Two areas of good news and two areas of concern
All signs show that the U.S. economy is emerging from the never-before-seen domestic and global economic shutdown caused by the COVID-19 pandemic.
Signs of Recovery
The U.S. gross domestic product grew at 6.4% for the first quarter of 2021; stubbornly high jobless claims have begun to recede; and consumer and producer prices have begun to spring to life as our economy restarts from the deep, pandemic-induced freeze. The U.S. GDP grew 6.4% in the first quarter of 2021.
Additionally, the International Monetary Fund projects 6% growth in the global economy for 2021.
As a sign of sharp growth, inflationary readings have picked up noticeably and are subject to debate between investors and central banks about whether these price increases are transitory or the bellwether of something deeper. The substantial rise in such commodities as lumber, industrial metals and food commodities as well as shortages in goods and services is due to, in large part, to the earlier-than-expected arrival of effective vaccines. In addition, the impact of large improvements in distribution of those vaccines in most of the developed world are rippling through the economy.
As one would expect, such financial institutions as credit unions have mirrored the path of the COVID-19 economy. Pre-pandemic, since at least 2015 credit union loan growth had increased at a very brisk pace. Through last three quarters of 2020, loan demand dropped substantially and share growth has increased substantially. Share growth has skyrocketed as the U.S. personal savings rate went from 7.6% as of Dec. 31, 2019, to 13.7% as of Dec. 31, 2020. The final quarter reading for 2020 is the highest rate in more than 60 years.
When we compare pre-pandemic to pandemic credit union balance sheets and operating statements, we can see how this loan growth versus share growth theme has played out. Using National Credit Union Administration data for aggregated credit union loan growth rates versus share growth rates, we can see that as of Dec. 31, 2020, loans increased 4.9% while shares increased 20.3%. In the fourth quarter of 2019 loans grew 6.17% and shares grew by 8.2%.
It is important to note that this measure where share growth outpaced loan growth actually began in the third quarter of 2019. Before that, June 2019 loan growth was 6.41% versus share growth of 5.97%. This resulted in loan-to-share readings going from 83.95% in 2019 to 73.23% in 2020. The 2020 loan-to-share figure was the lowest reading since the first quarter of 2015. Moreover, cash balances for credit unions ballooned to 13.04% as of Dec. 31, 2020. This measure was 7.74% as of Dec. 31, 2019.
This phenomenon has led to a drop in both interest income and non-interest income, which has in turn degraded return on assets. Net interest income to average assets went from 3.16% as of Dec. 31, 2019, to 2.82% as of Dec. 31, 2020. Over the same period, the reduction in loan growth also led to a drop in non-interest income to average assets, 1.36% to 1.32%.
As a consequence of these operational declines, return on assets went from .93% to .70%. It should be noted that during the same time period, delinquency rates and net charge-offs have actually declined .70% versus .60% and charge offs .56% versus .45%, respectively. However, it is important to note that the delinquency and charge-off data may be artificially low due to government stimulus, increased unemployment benefits and various forbearance programs. As the economy recovers and these various stimuli are removed, there could be a resurgence in delinquencies and losses.
What the Economy Holds for Credit Union Lending
The good news is two-fold. Firstly, the credit union industry remains very solid as the industry went into the pandemic crisis with very strong balance sheets. Secondly, as more Americans get vaccinated for COVID-19, a vaccination that came a lot earlier than many expected, the tremendous amount of savings built up by those who remained employed and have financial assets such as real estate and mutual funds are ready to spend as society opens up. Eventually, the reduction in personal savings will equate to a healthy environment for lending. However, this may take time, perhaps a bit longer than we currently imagine. The two areas of concern are the new and used car market and the residential housing market.
With regard to auto lending, there is the issue of scarcity and affordability. The production of new cars, SUVs and trucks has declined sharply due to a global shortage of semiconductor chips. As the pandemic set in, automakers strongly cut back on future orders. The use of “just-in-time inventory” techniques whereby manufacturers try to time inventory of goods needed to produce their products with their immediate need ended up being the wrong approach to the business cycle dilemma of COVID-19. Chipmakers simply didn’t have enough to meet demand, and this coursed through the global supply chain, creating shortages and bottlenecks. According to the Wall Street Journal, the market will see “new car production down sharply with chip shortage. But each company said the shortage of semiconductors that has forced production cuts across car factories world-wide since January will pinch production and inventories even more heading into the summer, just as American car buyers are turning out to dealerships in droves.” That means car shoppers in the coming months are likely to find slimmer options and fewer deals, from new and used dealerships and on the rental car lot.
Moreover, in the first half of April 2021, the Manheim Used Vehicle Value Index increased 6.81% in the first 15 days of April compared to March, bringing the value mid-month to a 52.2% increase from April 2020.
The good news is that collateral values are up, which will make risk-reward better on the lending side. However, new and used cars are likely to be less plentiful and less affordable, which could hamper getting loan production back to pre-pandemic levels.
The real estate lending market may be similar to the automobile market. Home values have increased dramatically as existing homes for sale have become scarce. New home construction is down, reflecting the sharp rise in the materials such as lumber and copper. Meanwhile, from the lending side, a recent Wall Street Journal article focused on the relatively new phenomenon of non-financial depository mortgage lenders like Rocket Mortgage that have recently gone public.
“Homes are selling at a blistering pace unseen since before the financial crisis, pushing up home values in nearly every U.S. ZIP code,” the article says. “Yet lenders are preparing for mortgage demand to cool in the coming months, the result of rising interest rates that make refinancing less attractive for a huge chunk of borrowers.
“The anticipated decline in mortgage volume is setting off price wars across the industry. That is driving down profit margins and spooking the shareholders of mortgage firms that went public closer to the height of the lending boom.”
As non-bank lenders like Rocket Mortgage go public, they have to react quickly and strongly to a drop in refinancing activity by tightening margins and narrowing primary-secondary yield spreads. This activity shows little sign of abating anytime soon.
Therefore, the sharp rise in home prices and the intense competition within the mortgage lending arena means less borrower affordability and greater competition and tighter profitability margins for credit union mortgage lending.
Taking all this into account, 2021 may be a tough year for the industry. However, based on where we were just a year ago, things have turned out a lot better than previously thought. The credit union industry is strong and will be able to take advantage when the unique economic situation described above abates, as it will.
Eric Salzman is a founding partner of Blanton Research LLP, with offices in New York and San Antonio, Texas.