By Roy Urrico
What do current economic trends tell credit unions about the likely financial conditions in the next year or two? “That is among the topics Bill Handel, vice president, general manager and chief economist at Raddon, a Fiserv company based in Milwaukee, covered in a conversation with Finopotamus..
Raddon, which provides innovative research, analysis and strategic guidance to financial institutions, suggested credit unions take a somewhat broader view of the current economic outlook. “That’s not to say your credit union shouldn’t focus on projected GDP (gross domestic product) numbers and Fed [the Federal Reserve] rate decisions,” said Handel.
He added, for the last few months, it seems every discussion he encounters about the U.S. economy in 2024 revolves around two questions: Will we experience a recession in the next 12 months or so? And how many times and by how much will the Federal Reserve cut the Fed Funds rate?
Handel explained in addition to understanding current economic trends, it is just as important to recognize the larger picture by considering other questions like:
· What kind of overall rate environment should the credit union industry expect? Will it be one of continued volatility or should some stability be expected? Will rates fall sharply or in a more measured way?
· How are these conditions likely to shape your members’ actions around borrowing, deposits and savings?
· In the event of a weakening economy, what segments of a credit union’s membership will be most affected, and how? How can you promote their financial security and that of your credit union?
Handel noted, for credit unions, success in 2024 and beyond will come from an “actionable understanding” of economic trends. “That understanding can empower you to respond in ways that are best for your credit union and your members by accurately answering these questions.
Handel weighed in on a number of topics.
Pending Rate Cuts
Handel mentioned the euphoria that look place in the marketplace following the news in December 2023 that the Fed expected three rate cuts in 2024, thanks to a slower pace of inflation. “I think people saw it and thought that was going to come immediately. It probably is not going to come as rapidly as some people would hope. So that is one thing to keep in mind in all of this.”
There are a couple of reasons for slower than anticipated rate changes, Handel indicated. “Number one, inflation is proving to be much more stubborn than what the Fed had hoped. The rate of inflation had dropped down to about 4% (the core rate). But that last 2% (the Fed) is trying to get to will be very tough, especially with the things that are happening internationally. There is going to be more pressure on prices, and that will make things difficult for the Fed.”
Commercial Real Estate
“Commercial real estate looks a little bit like the residential mortgage marketplace did in 2005 and 2006 in the sense that there are a lot of loans written as interest only. A lot of those loans are on properties which have significantly depreciated in value,” said Handel. He added, as these loans are coming due over the course of the next three or four or five years, it will be very difficult for those loans to be refinanced, because the values have dropped so substantially and interest rates have risen.”
He observed, “That's going to create some pressure in the commercial real estate markets overall, mostly impacting banks, maybe impacting a few credit unions. But the impact will be a systemic; whenever the banks start feeling pressure, they start restricting their lending. They raise their lending standards.”
That has a ricochet effect, noted Handel, typically causing things like layoffs to start happening as businesses cannot get the financing they need. “The bottom line is we see more continued softness in the economy this year. Again, I am not saying we are absolutely going to have a recession, but I think you are going to see continued softness.
Consumer Credit
Handel also focused on what he called “a bifurcated type of economic system” from the consumer standpoint. “If you look at the bottom quarter of the population, they are probably already in recession to a great extent. They are already feeling the pain. They have seen three consecutive years where their incomes have grown at a slower pace than inflation. So, their actual net purchasing power is declining.”
Nevertheless, consumers, according to Handel, continued to purchase, as confirmed by strong retail sales patterns. “They've continued to purchase primarily through a lot of the cash infusions that came from the federal government via COVID transfer programs and then credit cards.”
Handel added, “But now they are beginning to run out of (spending) space on those types of things. You will begin to see that manifest a little bit more in terms of loan losses in the industry.”
No Return to Refinancing Boom
For the credit union industry in particular, Handel believes even if interest rates do begin to come down, “We're not going to see a return of the refinancing activity that we were benefiting from for the last probably 15 years as an industry.” Handel added, “Even if rates do begin to come down somewhat in 2024, you will not see that much of a pickup in refinance activity. It is really more of a permanent shift, at least for several more years.”
Handel suggested, “The industry has to figure out how they become more effective in the purchase market. The banks, the credit unions really need to figure out the residential real estate marketplace to be effective in 2024.”
CFPB and Nonsufficient Funds (NSF)
There is going to be more pressure on earnings in the industry in 2024, noted Handel. “We're already seeing that among a lot of our clients. They are downsizing their earnings forecasts simply because they see continued pressure on the margins. And then you add the last piece out here, which is the regulation.”
Handel referred to the Consumer Financial Protection Bureau (CFPB) that he said “has been making a lot of noise around things like NSF fees.” Although it is targeting the largest organizations ($10 billion plus), he pointed out the proposed NSF rules are very different than the debit card interchange restrictions that were limited to the $10 billion plus organizations.
Because NSF fees are more visible to consumers, any reduction at one financial institution (no matter its size) will reverberate down the line. “I think you are going to see it spread across the entire spectrum because you cannot be in an organization that is charging $25 or $35 NSF fees where everybody else in your marketplace is charging $3.”
Auto Loans
Auto loans represent another area that Raddon and Handel are very concerned about. Said Handel, “If you look at automobile financing volume across the United States, it is up about 30 plus percent since the onset of COVID. Those are big numbers. It is the fastest growing category of consumer debts over that time span.”
Handel warned though, “The thing that is more concerning to us is that in that same time period, if you look at new automobile sales month by month, there were only two months in that entire span where automobile sales exceeded pre-COVID levels. What that tells you is we are not seeing that financing dollar volume go up because there are more car sales, there's actually fewer car sales.”
BNPL
“The whole notion of buy now, pay later (BNPL) was a big talking point about three years ago, right?” remarked Handel. “We have not seen as much focus on BNPL lately, but it is still happening in a very significant way, and it is another way in which the lower end of the (consumer market) is going to get caught in a financial trap. And we see that happening already, and we see it continuing to happen in 2024 through BNPL programs.”
Credit Union Preparations
Handel recommended credit unions need to avoid knee-jerk reactions and really focus on the long-term business model. “The key to success in this industry is really about relationship building with the membership. The relationship piece should drive the organization, not the finances. As you build greater balances with your membership and deepen the relationship overall, what we find is that the efficiency of your organization tends to grow. We find that the efficiency is driven more by revenue growth than it is by expense reduction.”
He also suggested implementing financial advisory type services especially for the younger demographics. “We're already seeing that major significant shift happening demographically where the baby boomers are leaving and the millennials are really becoming the dominant generation out there.”
However, millennials in many cases are not prepared for their new roles. “They do not really truly understand things. We really can play a very pivotal role there in terms of educating them to make the good financial decisions that will help them to remain healthy, especially in a little more challenging economic environment.”