As news posts highlight increasing COVID cases and warn of a second wave, we have to consider what such a scenario might mean for overall credit union industry performance – in particular if people cannot get back to work at pre-virus levels any time soon. Perhaps the best way to envision what could happen is to look at how industry health transformed over the time frame before, during, and after our last recession, which we do in the post below.
Of course there are more than a few exercise caveats to acknowledge – but we want to highlight the two most important. First, the causes of the Great Recession are way different than the causes impacting economic performance today. Second, the efforts towards economic stimulus during the Great Recession were much less extensive and sustained than what we are seeing today. Combined, these differences may mean that the impact on credit unions, despite the severity of the economic crisis, may be much less than what we experienced during the Great Recession.
That said, let’s press on by setting the stage with a view of credit union health as it was then and as it is now. The chart below compares the year-over-year %change in our benchmark HealthScore for the two years leading up to the start of the Great Recession (Q4 2007) and the two years leading up to today (Q4 2019).
The blue line illustrates percent changes in our score from September, 2005 through December, 2007 – the acknowledged first month of the recession. Any line above “0” means improving year-over-year health, and below “0” means declining health. Interesting to note that overall industry health had already started to deteriorate well before December, 2007 – with a negative change in September, 2006 and then a full-on consistent decline that would last from March 2007 until 2011.
The 2017-2019 timeframe, illustrated by the red line, starts off with a much different look. Health increased consistently starting in 2017 and continues to do so – but what we now see is a declining rate of improvement. In fact, the trend in this more-recent score now looks very similar in terms of slope and direction to the end of the 2005-2007 line. Keep in mind, December 2007 was the start of a recession. December 2019 was not a recessionary environment.
Peak unemployment at the height of the Great Recession was 10.6%. Our pandemic response has pushed the unemployment rate higher than that, with the latest figure listed as 13.3% by the Bureau of Labor Statistics. If we sustain unemployment at that level, might we encounter the same health trends seen during and immediately following the Great Recession? And what would that look like if we did?
Consider the table below. It contains the year-over-year percent changes in all of our component scores during and after the Great Recession. Fields in red indicate a year-over-year decline in the component. Again, the Great Recession lasted from December 2007 until June 2009.
Here are few table observations that shed light on what we could see if circumstances maintain or get worse than they are now:
- The threat of credit losses not only push down the delinquency and Texas ratio scores (the pchgDLTL and pchgTEXAS columns), but contribute to ROAA and Efficiency declines (pchgROAA and pchgEFF) as increasing funds are moved to allowance for loan loss accounts.
- Loan growth scores (pchgLG) decline as the willingness of credit unions to make loans declines, which in turn drives down scores for Loans to Assets (pchgTLTA). Declining loan growth would also further contribute to declining ROAA scores.
- Asset growth and Average Shares per Member scores (pchgAG and pchgASM) could bump up as members seek safety, but potentially at the expense of further pressure on Net Worth and ROAA scores (note: CUs didn’t respond quickly enough with rate adjustments during the early days of the Great Recession).
To name a few things we may have to contend with, here are a couple of data points that add to the level of concern:
- The industry today has a larger borrower base and greater exposure to members with higher credit balances. Yes, our Loan to Share and Loan to Asset ratios are lower today than they were then, but our average loan balance and average loan per member figures are $3,367.71 and $1,819.38 greater than they were then, respectively. Also, a greater percentage of members are borrowers today than they were then at 53% versus 48%, respectively.
- We’re starting off with roughly the same average Return on Assets ratio as we had then.
- We’re spending more today to make a dollar of income than we were then, with efficiency ratios more than 3 percentage points higher today than they were then.
- Our provision expenses are somewhat lower today than they were then, at .31% vs .4% then, meaning we may not be setting enough aside for pending risk.
Now all that said, we also have to consider quite a few industty positives:
- We’re better prepared than we were then. We’re battle tested with deep experience in proactively managing credit risk during a protracted downturn.
- We’re larger, and even though our average net worth ratio is lower, it is based on that larger asset base.
- We’re more diversified. Thanks to so many mergers and charter expansions over the last few years many credit unions have fairly diverse membership segments that each “behave” differently from one another. This may aid in risk mitigation.
- We already know how to live in an environment with very tight margins. Then we saw rates plummet and had to contend with a new, uncomfortable and seemingly intractable low rate environment (see the Fed Funds Rate chart below, courtesy of FRED). Today seems like more of the same.
Where Do We Stand Now?
So where do we stand today relative to Q4 2007? The table below shows a comparison of Q4 2019 to Q3 and Q4 2007 using that same year-over-year percent change in our score components (note that we will hopefully be publishing Q1 2020 data soon).
The industry saw improvements in only 8 of 17 components in Q3 2007, the last quarter before the Great Recession. Q4 was worse with improvement in only 7. By contrast, we ended 2019 with generally improving scores in 12 of 17 components. In other words, we’re heading into the COVID recession (barring major Q1 issues) with much firmer footing.
Things to Think About
We’re soon to head into the season when most credit unions engage in strategic planning. This will be an opportune time to (re)consider performance expectations, assumptions, risks/opportunities – and to assess how strong and relevant the underlying business model is – all in the context of “COVID.”
Here are the questions we encourage clients, and all credit unions, to consider:
- For your performance expectations, what is necessary to achieve or sustain baseline “survivability?”
- For your assumptions and risks/opportunities, what trends (local, state, national) could profoundly impact the business (in particular your performance expectations), and how should you respond?
- For your business model, what resources make up your model, and how are each positioned relative to your expectations, assumptions, and risks/opportunities? Do you have what you need built into the model? If not, how do/will you change?
- And finally, what is your exit strategy? Far too many credit unions ignored the trends during the Great Recession and essentially left decisions about their future up to regulators – meaning they were conserved. Be ready with a relevant plan to partner with a healthier credit union if things go south.
On that note, if you need some help planning, let us know. Sign up for one of our live planning process and tool demos, scheduled for Thursdays at 1:30pm Eastern throughout July, 2020, give us a call at (888) 217-5988, or complete our online contact request form.
Image by Gerd Altmann from Pixabay