Diligently tracking key trends in unemployment, lending and consumer spending can help your credit union optimize its financial condition.
Ever since the country essentially shut down in mid-March due to the spread of COVID-19, credit union and bank CFOs have been scrambling to reinforce their institutions’ allowance for loan loss account. As the leaders of $7 billion Ent Credit Union in Colorado Springs, Colorado—a fairly conservative institution with a fairly strong balance sheet and historically good earnings—we started socking money away into the allowance account immediately.
If our historical analysis showed we should have an expense of “x” in any given month, our actual provision expense was increased to “4x” in March of this year. Without any real data, what else could we do? From mid-March until June 1, Ent CU provided about $45 million in emergency loans and deferred, modified or provided forbearances on another $400 million of existing loans. We knew any actionable delinquency data wouldn’t be available until at least early Q4.
Several weeks ago, in an effort to narrow our estimates for losses, I sat down and thought to myself, “What do we know about this pandemic recession and how does it compare to the Great Recession?” Here’s a summary of how I’m answering that question today.
In straight unemployment numbers, the current recession is fairly comparable to the recession of 2008. Today, unemployment nationwide is 8.4%, down from a peak of double digits in April and May. In comparison, the national unemployment rate at the bottom of the Great Recession was about 10%.
But it’s also important to look at how the two recessions impacted different types of workers and consumers. The Great Recession was an equal opportunity recession. It didn’t matter whether you were a restaurant server or software engineer. You had a good chance of losing your job. Today’s COVID-19 recession has primarily impacted service workers in restaurants, hospitality, and travel.
If your credit union is in an area that relies heavily on tourism, you will likely feel a greater impact. If you rely more on near- and sub-prime lending to make loans, I think there is a greater likelihood that these impacted workers will have lower scores as well.
Residential Real Estate
Compared to the Great Recession, the residential real estate market is not yet negatively affecting the economy. By 2007, builders had created a glut of new homes. The market had also enjoyed several years of unprecedented demand from consumers, but probably 40% of that demand was driven by subprime and pick-a-payment mortgages. Once these loans started to default in earnest, demand went away because the products died a quick, painful death.
Fast-forward to 2020, and arguably the supply of homes is not enough to allow consumers currently renting to find an affordable home to purchase. That lack of supply has driven up home prices across the country. Yet demand from consumers is still strong. Arguably, COVID-19 and the impacts on daily life has led to three what I’d call “mini-trends” that time will tell whether they are longer-lasting:
- Consumers seem to be looking for bigger homes. Trying to work from home at the same time children are trying to learn from home creates space challenges.
- People with higher incomes seem to be more interested in buying a second home within driving distance. Concerned about the hygiene of hotels and rental homes and driven by concerns about air travel, a significant number of people are considering buying second homes within driving distance of major metropolitan areas.
- Higher-wage workers who live in high-cost areas and now can work from home are realizing home can be anywhere. This may create some displacement as these higher-cost metropolitan areas could see price declines in coming years.
How will all of this impact our mortgage portfolios? At least for the next year, I see little impact on losses based on residential real estate. That may be a relief to the sand states, although they also happen to be heavily dependent on travel and tourism.
Along with strong real estate values, the stock market is reacting very differently than in the Great Recession. When the stock market lost half its value from the market’s previous peak in 2007 to the bottom of the Great Recession, it had a significant negative impact on consumer spending. In economic theory, the wealth factor suggests that as personal wealth expands and contracts, so does a segment of consumer spending. With the combination of strong real estate values and stabilized stock prices, we have not experienced a wealth factor decline in consumer spending. Much to the contrary, there’s plenty of evidence that higher wealth consumers have not slowed their spending at all.
Most credit unions have fairly large auto loan portfolios, which could be a concern. Compared to 2009, Ent’s auto loan portfolio is now four times larger, yet our average monthly repossessions now are still 33% lower than what we experienced in 2008 and 2009. There’s a lot of room for our repossessions to go through the roof.
Let’s think about other aspects of the economy that are different now than in 2009 as they pertain to auto lending. In 2008-2009, gas prices had risen to $4 a gallon and more than that in California. People were ditching their SUVs and large trucks; even consumers with A credit were doing this, as many of them were laid-off. Today? Gas prices are low, and job losses have been minimal in higher-paying fields. However, if your credit union is heavily invested in affordable used car loans in a tourism and service industry area, you could have some challenges.
The number of repossessions—or frequency of loss—from your portfolio is only half the battle. The magnitude of loss is also very important in determining overall loss ratios. The amount you sell a car for at auction is just as important in determining losses.
When I use the percentage of the loan balance recovered by the sale at repossession as a proxy for the state of the used car market, 2009 was the worst market we’re ever seen; we averaged a little over 40% recovery in 2009.
In 2020? We’re still running close to 60%. Such factors as average term of the loan and loan-to-value at origination can make this recovery percentage a bit tougher to analyze. Things may change in 2021 as the supply issue for new cars corrects itself. Currently, a lack of supply is driving up used car values as many desirable vehicles just aren’t available new. That’s another reason I don’t see auto losses being a problem.
The Bottom Line? Be Diligent
Everything I’ve shared leads me to believe we have plenty of money in our allowance account right now. The allowance represents expected losses for the next 12 months, at least for us credit unions not yet covered by Current Expected Credit Loss.
But the economy—like the virus—is fluid. Every passing quarter may present us with a set of economic conditions that will cause losses to change dramatically. The earlier your credit union sees the economy and key metrics changing, the better. When you spot a relevant trend in a timely fashion, you can adjust your loan loss allowance accordingly and lessen the negative impact on your financial condition.
CUES member Bill Vogeney is chief revenue officer and self-professed lending geek at $7 billion Ent Credit Union, Colorado Springs.