CREDIT UNIONS have started 2013 on a strong note. The pace has picked up from 2012, a year that already saw a record number of new member owners and an all-time high in lending activity.
These results come as the U.S. economic outlook continues to improve. Over 900,000 jobs have been added through the first five months of the year, stocks are near all-time highs, and home prices are rising at a doubledigit pace in the latest Case-Shiller Index. These and other trends are helping to push consumer confidence to a five-year high, and consumer credit is expanding as a result.
With the economy returning to a more normal state, the environment is changing for credit unions. In the first two years of the downturn, there was a flight to quality by consumers that resulted not only in double-digit deposit growth but record loan originations among credit unions. In 2010 and 2011, consumers became more vocal in their push for a financial system that would act more in their interests rather than those of the largest institutions. The Occupy movement and Bank Transfer Day in November 2011 were expressions of this push, which helped provide a lift in credit union membership that carried into 2012.
As 2013 begins, capitalism has reasserted itself. The U.S. economy, despite the cutbacks in government spending due to the sequester, is the strongest in the world. Companies are reporting hearty profits and banks recorded their highest quarterly earnings ever in the first quarter. Competition is back in lending, particularly for consumers with solid credit profiles.
The changing market dynamics mean that credit unions have to redouble their efforts to secure their position as members’ go-to financial provider. An improving economy will lead to a wind down of the Fed’s expansionary policies and interest rates will begin to rise. When this occurs, will it become a rate game that credit unions play versus their competitors, or will cooperatives be able to continue to convey a unique value proposition that goes beyond rates and fees?
Credit unions’ countercyclical design played out well during the downturn. Now it is time to establish their role in an emerging growth environment. Will the cooperative financial services model continue to demonstrate its difference when times are good, or do cooperatives exist just to respond in times of crisis?
Certainly credit unions have played a valuable role in members’ lives throughout their more than 100-year history. But they have never before had such a visible market presence, and with success comes new challenges. Can they continue their momentum in 2013 and beyond?
Member Ownership Expands By 2 Million
Total membership reaches 95.8 million
Average member relationship rises 2.5%
Credit unions’ cooperative structure is fundamentally reflected in each member’s ownership stake. Over the past year, member ownership in credit unions has expanded by nearly 2 million to reach 95.8 million nationwide. The 12-month membership increase through first quarter 2013 is up 12% from the nearly 1.8 million members added the year before and is quadruple the annual increase posted in the first quarter of 2011. Is there another industry in America that has seen its ownership ranks expand by over 4 million consumers in the past three years? It would be a challenge to identify one.
Although this increase to the cooperative ranks is significant, the goal for most credit unions is not just membership growth but also the growth of member relationships. By that measure, credit unions are also making solid progress. The average member relationship, including both loan and share balances, has increased 2.5% over the past year to reach $15,581. Just five years ago this key measure was below $13,500.
The success in member relationship growth is occurring in credit unions of all asset size. In fact, the growth rate of member relationships in credit unions between $10 and $100 million in assets is 3.0% — well above the national average. Credit unions below $10 million in assets are growing relationships at 2.2%, higher than the 1.7% growth rate posted by the billion dollar and up credit unions.
Checking Account Growth Indicates Relationship Success
Share draft growth exceeds membership growth by almost 700,000
Total deposits surpass $922 billion
One indicator of the success credit unions have had in growing member relationships is in the number of new checking accounts that have been opened. The checking account is viewed as the anchor of a consumer’s primary financial institution relationship. As free checking goes away at banks, many credit unions have been focusing marketing efforts on the value of their checking options.
Over the past year, credit unions have increased the number of share draft accounts by almost 2.7 million – exceeding their membership growth figures by more than 690,000. In other words, these accounts are not only attracting new members but also expanding relationships with members who may have had limited dealings with their credit union in the past. As of March, there are 49.6 million share draft accounts open at credit unions, equivalent to 51.8% of the membership base.
Given the growth in the number of checking accounts, it is not surprising that the core deposit accounts — regular shares, share drafts and money market accounts — are driving total share growth in credit unions. Total share growth is 5.1% over the past year, with credit unions’ deposit base topping $922 billion in March. The growth rate of each of the core deposit categories exceeds that of the total portfolio.
Regular shares, the largest component of the deposit portfolio, are setting the pace with a 10.3% growth rate, followed by growth in share draft balances of 8.5%. Money market share account balances are up 6.1% over the past 12 months. The balances in these deposit categories total $643.5 billion — or more than two-thirds — of the total share portfolio. This provides credit unions with a strong base of lower cost, sticky deposits from which to lend to members.
Part of the reason for the growth in these categories is members’ preference for keeping their funds in liquid accounts at a time when interest rates remain near historic lows. One outcome of this is that share certificate balances are down 3.3% over the past year, the only deposit category to decline over that period. IRA/Keogh balances are up 0.8% since March 2012.
Loan Originations Rise 14% To A New First Quarter High
Credit unions originate $43.5 billion in consumer loans; 14.3% of all auto loans in U.S.
First mortgage lending exceeds $31.2 billion in the first 90 days of 2013
Members are continuing to turn to credit unions for their borrowing needs. As consumer spending picks up, credit unions are lending at a record pace. Loan originations through the first three months of 2013 totaled $82.7 billion, a 14.1% increase from the previous record set last year. Lending activity is up across the board with new first quarter highs set in consumer, first mortgage, and member business loan originations.
Consumer lending, including auto loans and credit cards, accounts for over half of all originations. Originations in this category are up 10.9% over the past year, reaching $43.5 billion. New car buying activity by members is certainly a factor in this increase. New car sales are on the rise in 2013, with manufacturers posting monthly sales results not seen since prior to the Great Recession. Credit unions captured 14.3% of U.S. auto financing activity in the first quarter, slightly below the 14.6% captured in 2012, but the increased volume of car sales is resulting in higher loan volume.
First mortgage lending is accelerating at an even faster pace in 2013, up 19.3% versus the first quarter of 2012 to reach $31.2 billion. Mortgage rates remained near all-time lows during the quarter, spurring on additional refinancing activity by members. Although credit union call report data does not break out refinancing and purchase mortgage activity, the Mortgage Bankers Association reports that 74% of mortgage originations in the first quarter were refis. Credit unions are attracting refinance activity with creative loan options such as CitizensFirst Credit Union’s ($382M, Oshkosh, WI) “create your own mortgage” program which allows members to select a fixed rate mortgage with anywhere from a five- to twelveyear term. The product is targeted to members that are looking to enter retirement without any mortgage debt.
While refinancing activity remains strong, some credit unions are also using the low rate environment to attract first-time homebuyers. Home prices are rising but remain below pre-recession levels in many areas, providing another reason for first-time buyers to get into the market. Navy Federal Credit Union ($54.2B, Merrifield, VA) is offering a HomeBuyers Choice Mortgage that provides 100% financing with no down payment or private mortgage insurance requirement in a fixed rate loan. For 25 years State Employees’ Credit Union ($26.5B, Raleigh, NC) has been offering a similar first-time homebuyer program with 2-year and 5-year adjustable rate options. The program recently surpassed $1 billion in originations since its inception.
Member business loan originations rose at the fastest pace compared to the first quarter of 2012, up 21.6% to $4.0 billion in the first three months of 2013. As many banks raise their minimum amounts on business loans, credit unions are finding opportunities to lend to small businesses that need capital but fall outside of the parameters set by larger institutions.
First Quarter Loan Balances Increase The Most Since 2008
Autos are the fastest growing category of the loan portfolio
Sales of mortgages on the secondary market accelerate to $18 billion
The first quarter of the year is typically a slow period for loan balance growth as members pay down borrowings after the holiday season. However, record loan volume during the quarter resulted in a $2.1 billion increase in loan balances for the first three months of 2013. Although this represents only modest growth in the $607.3 billion portfolio, the dollar increase was the highest for the first quarter since 2008 — another indication that members’ financial situations are returning to normal.
Loan balances have increased $27.9 billion or 4.8% over the past year. This is more than double the 2.1% pace reported last March, as all loan categories posted a faster growth rate over the past 12 months than were recorded a year ago. Auto loans posted the highest growth rate, up 9.1% over the past year. New auto loan balances rose 10.6%, a significant turnaround from the 4.0% annual decline reported in this category in the first quarter of 2012. Used auto loan balances are up 8.2%, driven in part by credit unions’ continued efforts to lower members’ monthly payments by refinancing auto loans initially financed with other lenders. Auto loans account for 30% of the total loan portfolio as of March.
Real estate loan balances are up 2.0% since March 2012, led by first mortgages. First mortgage balances are up 5.2% over the past year and account for the largest portion of the industry’s loan portfolio at 42%. The growth of first mortgage balances is limited due to record secondary market sales. Credit unions sold $18.1 billion of first mortgages to the secondary market in the first quarter — a new high for the quarter — representing over 58% of originations during that period. Fixed rate first mortgages account for 14.5% of total industry assets as of March, unchanged from a year ago as credit unions maintain a focus on asset liability management.
The rise in first mortgage balances offsets a 7.5% decline in other real estate loans. This category, primarily home equity loans, is affected by the loans often being included in first mortgage refinances. However, credit unions are beginning to see more home equity lending activity as home values rise. Other real estate loan originations rose 5.3% from the first quarter of 2012 to $4.0 billion.
The Investment Portfolio Tops $416 Billion
Average investment yield drops to 1.07%
Credit unions are increasing their duration slightly
Loan and share growth rates across credit unions are converging and are closer than they have been since 2009. Still, new shares continue to flow in at a faster pace than loan balances are rising. As a result, liquidity remains high with the loan-to-share ratio at 65.9% as of March.
The credit union investment portfolio reached $416.6 billion at the end of the first quarter, up 5.0% over the past year. Agency securities are the dominant component of the investment portfolio, accounting for 48.1% of total investments. Investments in banks and S&L’s, primarily jumbo certificates, are up 5.5% to $48.6 billion. Corporate credit union investments account for 8.4% of the investment portfolio as of March, with balances down 21.9% over the past year.
The yield on the investment portfolio continues to fall as interest rates remain low. The average yield has fallen 28 basis points over the past year to 1.07%. However, with 29% of the portfolio in cash and equivalents, new investable funds are often invested in rates that are closer to the overnight Fed Funds rate, typically near 20 basis points. Credit unions have extended the maturity of their investments slightly over the past year, with investments maturing in more than one year rising from 52.7% to 53.4% of the portfolio.
The Net Interest Margin Tightens As Assets Reprice
NIM drops 21 basis points to 2.77%
Operating expenses rise almost 6% but hold steady as a percent of assets
Total revenue declined 1.2% from the first quarter of 2012 as both loan and investment interest income declined despite larger portfolios. The annualized average loan yield is 5.16% as of March, a 44 basis point drop over the past year. Though lower, the loan yield is more than 4.8 times the average investment yield, underscoring the importance of converting shares into loans in the current interest rate environment.
Interest expense is also declining as a result of the interest rate environment with the cost of funds falling 19 basis points to 0.68% or 68 basis points. The decline is not enough to prevent continued tightening of the net interest margin. The margin is 21 basis points lower than it was as of March 2012, reaching 2.77%. This is the lowest net interest margin on record for the industry.
Asset repricing was only partially offset by a 9.5% increase in noninterest income. Fee income is up 4.3% over the past year while other operating income has risen 15.5%. The latter category is seeing a lift due in part to the income generated from record sales of first mortgages to the secondary market. Other operating income also includes interchange income from debit cards, and many credit unions are experiencing higher debit card volume as more checking accounts are opened by members. The higher volume is helping to offset reductions in interchange fees related to the Durbin Amendment.
Operating expenses have risen 5.6% versus a year ago, driven largely by a 5.5% increase in salaries and benefits. Credit union employment hit an alltime high in the first quarter with nearly 249,000 full-time equivalent employees. Other expenses are being managed, with only loan servicing expenses rising at a double-digit pace — a result of increased lending activity. Operating expenses as a percentage of average assets is steady at 3.04%.
Asset quality is continuing to improve, with the delinquency and net charge off rates falling to 102 basis points and 61 basis points respectively. This is leading to a lower provision for loan loss expense. The $698K quarterly provision expense is the lowest for the industry since 2007. As a percentage of average assets, the provision expense is 27 basis points, less than a quarter of its 1.12% peak recorded in the fourth quarter of 2009.
The Highest Capital Ratio Since 2008
Net income rises 5.2%, reaching $2.2 billion for the quarter
The net worth ratio rises to 10.3%, the highest level since 2008
The combination of higher noninterest income and a lower provision expense is helping to offset the tighter net interest margin across credit unions, and net income is up 5.2% versus the first quarter of 2012. The $2.2 billion in quarterly earnings is equivalent to an 86 basis point return on average assets. Excluding accruals for NCUA assessments, ROA matches the March 2012 pre-assessment ROA of 83 basis points.
Higher net income is pushing the net worth ratio higher. The 10.3% net worth ratio as of March is the highest for the industry since 2008. When including the allowance for loan losses, total capital is $117.9 billion or 11.0% of assets. This is also the highest total capital ratio in five years.
Acting Boldy As The Environment Changes
Credit unions have continued to steadily move forward since the Great Recession began. The ongoing focus on serving members has driven record results in a number of measures. However, the uncertain economic and regulatory environment kept some cooperatives from taking on major initiatives, and others needed to focus on buttressing their internal operations to manage through oncoming challenges.
Although uncertainties remain in the U.S. economy — especially regarding the interest rate environment and the effect of Washington’s inaction on the federal budget — both national and local economies are on stronger footing than they have been in the past five years. As a result, credit unions are looking to invest in people and technology at levels unseen in recent years.
The challenge for credit unions is to shift from managing through nearterm uncertainties to planning for the critical long-term investments that are needed to enhance member value. While competition is returning, credit unions have come through the downturn in a stronger position than ever. The ongoing commitment by credit unions to the communities they serve shone through as others pulled back. As a result, advantages are available to these cooperative institutions that weren’t there five years ago.
Realizing opportunities to affect the well-being of members in new ways will likely involve not only individual initiatives but also partnerships that leverage the strength of the industry and the communities that credit unions serve. The opportunity is there. So is the momentum. It is time for credit unions to think and act boldly.