How can CUs help members stay financially healthy in a changing fiscal environment?
After successfully coping with a once-in-a-century pandemic, credit unions now face the challenge of rising interest rates, as the scourge of disease is replaced by the scourge of inflation.
The pandemic turned out to be good for credit unions’ bottom lines, largely due to the financial assistance that flowed from Canada’s federal government to individuals. Members stashed a lot of that cash in safe, low-interest deposits, something that helped boost credit unions’ margins since it provided a low-cost source of funds.
On March 2, the Bank of Canada raised its trendsetting policy rate a quarter point to 0.5%, the first increase since 2018. It warned that “the unprovoked invasion of Ukraine by Russia is a major new source of uncertainty. Prices for oil and other commodities have risen sharply. This will add to inflation around the world.”
Meanwhile, in the U.S., where the inflation rate is at almost 8%, the Federal Reserve approved a 0.25% interest rate increase in mid-March.
Central banks in Canada and the U.S. are expected to raise interest rates as many as a half dozen times over the next two years. Some observers say this shift should also be good for credit unions, but they will need to focus on advising and educating members.
Pandemic Recession Averted
People have a lot of savings that they are ready to deploy when pandemic restrictions are lifted and “service companies are raring to reopen,” says Bryan Yu, chief economist at Central 1 Credit Union, Vancouver.
Yu says the Bank of Canada feels the Canadian economy has already fully recovered from any pandemic setbacks, with inflation running at 5%, far ahead of its 2% target. He expects the central bank will raise its overnight policy rate, currently at 0.25%, in a series of quarter-point increments, to at least 2% by late in 2023.
When the pandemic hit in March 2020, the biggest economic fear was that a recession would be triggered by the widespread business closings and restrictions. That month, the Bank of Canada cut its overnight policy rate three times, from 1.75% to 0.25%, where it has been until now.
But the bank’s biggest fear turned out to be largely a non-issue, although thousands of small businesses were hammered by the restrictions and closings.
“Employment recovered more quickly than expected,” Timothy Lane, deputy governor of the bank, said during a recent speech. “And inflation persistently ran much higher than anticipated and is now well above our target.”
The difference was the amount of government aid, Lane said. This meant that “the disposable income of Canadian households actually increased during the pandemic and business bankruptcies declined—both unheard of during a recession. Households were able to increase savings and pay down non-mortgage debts.”
Rajat Varma, VP/treasury at $17.3 billion Servus Credit Union, based in Edmonton, agrees. “The sheer magnitude of the stimulus that was put into the system really changed the narrative.”
What’s Ahead in 2022?
This year Varma expects consumer spending on services will jump due to the pent-up demand caused by COVID-19 restrictions.
The Bank of Canada believes the jump in inflation has been driven by supply-chain issues around the world and that those will ease later this year, but Lane said it will be ready to push rates higher if its analysis is wrong and inflation persists. “We will be nimble—and if necessary, forceful—in using our monetary policy tools to address whatever situation arises.”
Yu warns that one of the challenges for credit union members will be rising mortgage rates on top of a large jump in home prices, a combination that could force them to allocate more of their money to shelter.
Home sales boomed during the pandemic, which drove the price hikes, so Yu expects housing sales “could easily fall 15% to 20% this year” as sales return to normal, which will be a drag on lending in that sector.
“Credit unions should expect that loan growth will slow this year and may be negative in some cases,” he says.
Yu believes most credit union members are in good financial shape, and while they will draw down and reallocate the money they parked in deposit accounts, there should not be a large jump in delinquencies.
“I don’t think there are a lot of big risks for credit unions right now,” he says.
Credit Unions Focus on Financial Literacy
The shifting economic landscape has some credit unions putting a greater focus on increasing their members’ financial literacy and providing advice to keep them on track.
“Many households in Canada are within $100 or $200 of a balanced budget at the end of the month, so rate hikes coming will absolutely impact those households, and they will need to make some sort of trade-off decisions,” said Mark Perkins, chief operating officer at $5 billion FirstOntario Credit Union, with its head office in Hamilton, Ontario.
“The good news for those who own a home is their homes are increasing in value at a substantially higher pace than interest rates are rising,” Perkins says.
More than half of Ontarians are concerned about the impact of rising interest rates on their financial situation, with a third fearing the hikes could push them toward bankruptcy, according to a recent poll conducted by Ipsos on behalf of MNP Ltd.
“We need to keep in mind that a lack of financial literacy impacts the poll findings, as we know many Ontarians don’t have a good grasp of how their personal finances can be affected by interest rate increases,” says Caryl Newbery-Mitchell, an insolvency trustee with MNP Ltd.
Daryl Hosein, VP/treasury at $21.4 billion Coast Capital Savings Federal Credit Union, Surrey, British Columbia, points out the economic outlook can change quickly, noting that just a few months ago, few predicted a jump in inflation.
He says that rather than advising members on the exact level of interest rate changes, credit unions need to tell them: “You need to have a plan moving forward and be thinking longer-term about your goals and your debt loads and how are you going to manage that over time.”
Hosein says the stricter stress tests introduced to qualify buyers for mortgages have helped protect borrowers and “provide some built-in safety capacity into the system.”
“What we continue to talk to our members about it isn't just specifically about this mortgage or that deposit, it’s about the entire relationship we have. We want them to talk with our financial planners to look at their entire situation: ‘Not just your finances, but your goals. What are you trying to achieve? Where are you trying to go? What's important to you?’”
He says Coast Capital Savings FCU wants members “to think of it as building out your own financial team.”
Hosein says it’s important that members realize they shouldn’t focus on trying to game the market or chase extra basis points on returns because that could set them up to fail.
In fact, at least one well-known economist, David Rosenberg, believes the tide is already turning and inflation will quickly disappear. The noted stock market contrarian argues the biggest economic risk in coming months will be deflation and falling home prices. “We’re going to have asset deflation—the question is how big,” he says.
Varma says the past year was a good one for Servus CU with strong growth in loans and deposits. “We certainly expect that there will be a slowdown in activity. We’re starting to see a little bit of that already in terms of our loan activity and we’re already seeing a slowdown, especially in the residential market.”
An area of likely growth is business loans, Varma says. Many businesses that have been hamstrung by COVID-19 restrictions are looking to expand and grow. “We have seen some good growth in our business loans and we are positioned to continue to do that. Our capital position is strong enough that we can support some above-average growth for businesses as we move out of the pandemic.”
Varma notes that even as interest rates paid on deposits start to rise, savers will still be hurting. “We're still going to be in negative real rate territory, with inflation running at 5%. Those who are risk-averse will be happy, but they’re still not ending up ahead in terms of spending power.”
Varma says Servus CU is always keeping an eye out for borrowers who may face challenges as rates rise.
“We’re trying to help those people cope with their finances and figure out if there are any workout situations that we can deal with,” he says. “That peak hasn’t come yet. We’re expecting it to come in the next couple of months as rates start to rise.”
Varma says Servus CU has seen exponential growth in its wealth management services area as members have looked for asset growth while interest rates have been so low.
Looking ahead at this year, “we’re positioning ourselves a little bit more defensively than we would normally,” Varma says. Servus CU expects member spending will pick up as the economy reopens, and that will drain money from its deposits.
“Canadians are sitting on a historically high level of savings at this point, so at what point does that normalize? Or is this just how Canadians will operate moving forward? Those are some questions we have, and predicting member behavior—that’s not the easiest thing in the world. So, we’re just thinking about a cautious approach.”
The Implications of Digital Banking
One change during the COVID-19 years that all credit unions have faced is the rapid, widespread adoption of digital banking.
“I think we as an industry accelerated digital adoption by 10 years in two years,” Hosein says. “This is going to have implications on Coast Capital as well as the industry going forward, because there really is no going back after you get a taste of the convenience and the ease of doing the majority of your banking online and electronically.”
But Perkins of FirstOntario CU highlights one of the dangers of the digital move.
“The evolution of the industry and the move online to digital lending means the speed at which you can acquire debt is certainly doing a disservice to some people who do not have a healthy relationship with debt,” Perkins warns.
“I believe we’re not here to take orders from members. We’re here to help them; we’re here to give them advice,” he says. “But when you have the competition out there providing quicker, faster ability to acquire debt that fits into a monthly budget, it is hard to interject into those conversations. People are less passionate about financial health than they are about a lot of other things in society these days.”
Perkins notes there has been a shift in the industry in recent decades and now home and car buyers focus only on their monthly payment, not the true cost of any debt.
“A car salesman doesn’t tell you the price of the vehicle, just the monthly payment,” he says. “They want to sell you a payment. We are trying to educate people, to the best of our ability, to look at the total cost. If you look at the price of a house, with the interest over 25 years you can be paying double the purchase price of the house, especially if you refinance during the lifespan of the mortgage.”
Perkins says the credit union wants people to realize that “sometimes it makes sense to feel a bit of short-term pain to get out of that cycle of debt sooner. The big win is when you see the lightbulb go off with one of our members and you really help them change their perspective and look at a healthy long-term financial strategy.”
An innovation at FirstOntario CU has been the development of its Member Solutions team, which launched during the pandemic. It uses video and online technology to provide advice as well as loans, mortgages and investments, dealing with inbound and outbound calls with a proactive, advice-based approach that reaches people in their homes.
“It is the responsibility of credit union executives to ensure financial literacy is a component of everything we are doing for our members. I strongly believe in that,” Perkins says. “I think it can be easy to lose sight of that responsibility on occasion when there is money on the line.
“Sometimes the loan they can qualify for isn’t the right long-term decision for their financial health. It is easy to be an order taker and say, ‘They could just get this deal somewhere else, so I’ll do it.’”
Perkins says credit unions need to stop at that point and consider the impact on their members. “It’s not that we won’t do it, but we have a responsibility to have that conversation along the way.”
Perkins says FirstOntario CU expects some margin compression as rates rise.
“The whole system has benefited from the spread and the widening of the margins in recent years. But rising rates will flip the script. There will be some margin compression, which will lead to reduced revenue.”
He doesn’t expect a wave of mortgage refinancing since rates are not going to jump dramatically enough to make it worthwhile. “Anybody who has locked in over the last three years, it doesn’t make sense for them to break it and lock in now because rates are low and we’re not seeing a huge spike,” Perkins says.
For its part, FirstOntario CU has “spent the last three plus years creating diversity in our income stream,” Perkins says. It has become involved in direct real estate investments that have provided an alternative revenue source as well as private and public markets.
Hosein notes that inflation can actually help borrowers since they will be paying back loans “with new dollars, which are more abundant. There’s quite an interesting dynamic at that play that could potentially help with real debt levels.”
Another positive factor, he says, is that “even though variable rates are changing, that generally doesn’t change an individual borrower’s payment amount from month to month. The rates might be going up but the actual payment that a member is going to make month over month would not generally change during their term.”
This provides members with some protection from large changes in their monthly costs. Additionally, when you work with members to look at their needs holistically, it becomes easier to come up with a plan that they can stick with over time.
Also, while inflation and rising rates may hurt in the short term, over the long term, many members may benefit from higher wages and earnings, Hosein says. cues icon
Art Chamberlain in a writer based in Campbellford, Ontario, who reports on the credit union system.