2012 Economic Forum
Catalyst Corporate
Twelve Centennial Park Hotel, Atlanta, GA
1:45-2:45 pm, Wednesday, September 26, 2012
U.S. Economic Outlook
& Its Impact on
Financial Institutions
Steven W. Rick
Senior Economist
Credit Union National Association
PO Box 431
Madison, Wis. 53701, USA
Telephone: 608-231-4285 Facsimile: 608-231-4924
E-Mail: srick@cuna.com
1
Deposit Factors:
Investment Factors:
1.
2.
3.
4.
1.
Federal Reserve announced that economic
conditions “are likely to warrant exceptionally
low levels for the federal funds rate at least
through mid 201 is forcing a reevaluation of the
duration of investments.
Rising loan growth will reduce investment
portfolio growth in 2013.
Financial institutions are sitting on record levels
of excess reserves ($1.6 trillion) earning 0.25%.
Excess liquidity is punishing earnings with
short-term investment yields lower than deposit
interest rates.
2.
3.
4.
5.
6.
7.
8.
CU Balance Sheet
Economic uncertainty and members’
preference for liquid funds will buoy deposits.
Large interest rate differentials between loans
and savings will encourage households to pay
down debt rather than save any surplus funds.
Households using existing savings balances to
pay down debt will reduce the size of balance
sheet.
Rising oil prices will reduce savings balances.
Inflation rates higher than deposit rates will
produce negative returns on savings deposits.
Large federal deficits may lead to expectations
of higher future taxes fostering additional
savings growth today.
The national savings rate is back to the level in
the late 1990s.
Falling home prices will encourage thrift.
(% of 2012 Assets)
Assets
Liabilities + NW
Investments (38%)
Deposits (87%)
Annual Growth Rates
Annual Growth Rates
07
08
09
10
11
12
07
08
09
10
11
12
4.6
9.1
30.0
12.5
12.3
7.0
5.1
6.9
10.3
4.4
5.2
5.0
Loans (57%)
Net Worth (10%)
Annual Growth Rates
Annual Growth Rates
07
08
09
10
11
12
07
08
09
10
11
12
6.5
6.7
1.2
-1.2
1.1
4.0
7.1
3.2
-1.2
5.0
7.6
7.9
Loan Factors:
1.
2.
3.
4.
5.
6.
7.
8.
Economic recovery and accompanying job growth
will encourage borrowing in 2013.
Rising consumer confidence will encourage
spending.
Rising stock prices will produce a “wealth effect”
fostering increased consumption.
Households have accelerated loan payments and
payoffs which has outpaced originations and reduced
loan balances. But deleveraging should fade in 2013.
Low spending in 2009-2011 has created much pentup demand for durable goods. Auto loans, credit card
loans and purchase mortgage loans will be strong
growth areas.
The recession has created a large pool of potential
borrowers with sub-prime credit scores.
Rising auto sales may reduce 0% financing offers.
Udall-Snow Small Business Lending Enhancement
Act is moving in Congress to raise the business loan
lending cap from 12.25% to 27.5% of assets for CUs.
Net Worth Factors:
1.
2.
3.
4.
Rising net income in 2013 will raise return-onequity ratios.
Capital contributions will outpace asset growth
raising net worth-to-asset ratios.
BASEL III will be an impetus for Congress and
NCUA for capital reform.
Alternative capital (subordinated debt) is a top CU
legislative priority.
2
1.
Yield on Assets
2.
07
08
09
10
11
12
5.89
5.56
4.91
4.46
4.05
3.95
3.
4.
5.
6.
- Cost of Funds
07
08
09
10
11
12
2.78
2.42
1.73
1.21
0.92
0.85
1.
2.
3.
4.
= NIM
1.
2.
07
08
09
10
11
12
3.10
3.14
3.18
3.25
3.12
3.10
3.
+ Fee/Other Income
07
08
09
10
11
12
1.35
1.28
1.23
1.33
1.31
1.30
1.
2.
3.
- Operating Expenses
1.
07
08
09
10
11
12
3.38
3.56
3.16
3.30
3.26
3.15
2.
3.
- Provision for loan
losses
07
08
09
10
11
12
0.43
0.88
1.11
0.78
0.50
0.40
4.
1.
2.
3.
4.
= Net Income
07
08
09
10
11
12
0.64
-0.02
0.18
0.39
0.68
0.85
1.
The Federal Reserve’s Q3-2 program (print money to buy
$40 bil of MBS per month) and Operation Twist will keep
long-term interest rates low through 2013.
Banks/CUs are weighing the marginal risk (credit/interest
rate) versus marginal return (additional YOA) of alternative
assets to boost NIMs.
Aggressive loan pricing will lower YOAs.
Repricing of maturing loans will lower YOAs.
Rising loan growth will raise YOAs.
Rising short-term interest rates in 2015 will raise yields on
short-term investments.
Rising short-term interest rates in 2015 will increase COFs.
Continued repricing of maturing CDs is lowering COFs today.
Excess liquidity will allow Bank/CU deposit rates to lag
increases in market rates in 2015.
Ultra-low market interest rates are preventing the pricing of
deposits below market, reducing earnings opportunities .
NIM expected to rise in 2015 as YOA rise faster than COFs.
A flatter yield curve in 2012 will put downward pressure on
NIMs by making ST borrowing and LT lending less lucrative.
Banks/CUs are reevaluating their “GAP” strategy due to
changing interest rate forecasts.
The interchange fee cap rule was implemented on October 1, 2011.
This will cap the maximum fee charged per debit card transaction to
21 cents (plus an additional 2-3 cents for fraud prevention) for
institutions greater than $10 billion.
Concerns over the effectiveness of the less than $10 billion “carve
out” rule. Statutory exemption may not work as intended, but it will
take a few years for small institution interchange rates to converge
to large institution rates. Interchange income may decline in 2012.
Changes to overdraft rules will affect fee income depending on
member behavior. Recession induced financial stress has
incentivized consumers to alter behavior to minimize penalty fees.
Rising compliance costs for new Dodd-Frank Act regulations
and new Consumer Financial Protection Bureau rules.
NCUSIF premiums expected to be zero in 2012 due to large
build up of reserves for insurance losses and fewer CU
failures.
Corporate stabilization assessments were 9.5 bps of insured
shares in 2012 and expected to be 7.5 bps in 2013.
Slowdown in branch expansion and continued cost
containment efforts will lower operating expense ratios.
Most banks/CUs have sufficiently funded allowance for loan
losses.
Job growth will improve credit quality and lower provisions.
Local foreclosures will have a lingering impact on PLLs. Today
11 million homeowners are underwater. Ten percent of mortgage
holders owe at least 125% of the property’s value.
Home prices fell 5% in 2011 and are expected to stabilize in 2013.
10% of all mortgages are at risk of foreclosure.
ROA remains below its long-run average and questions
remain whether this will be the “new normal”.
3
Credit Union Savings Growth
Annual Percent Growth
25
22.0
22.0
20.0
20
16.0
15.0
15
14.0
11.0
10
11.3
10.6
10.0
10.0
9.0
10.6
8.4
7.0
7.0
7.0
5.0
5.0
6.9
6.2
5.1
6.06.0
5.0
5.0
5
4.1
3.0
5.2
4.4
4.8
6.0
5.0
3.0
0
80
82
84
86
88
90
92
94
96
98
00
02
04
06
08
10
12
A stagnant economy over the next few years will make balance sheet growth difficult. CUs need to
focus on sales management and programs designed to increase deposits. For individual CUs, mergers
may be a viable strategy for growth. New regulations will pressure smaller CUs to merge. Mergers can
produce cost efficiencies in the long run. Large banks are driving customers to CUs.
Credit Union Loan Growth
(Annual Percent Growth)
30
25.0
25
20
18.0
15.9
15.0
14.0
12.012.0
15
10
11.0
8.0
8.1
9.1
5.8
5
3.0
2.0
11.0
10.010.8
10.610.9
8.3
7.0 7.5
7.8 7.6
6.7
5.0
4.0 3.3
2.9
3.0
1.2
1.1
0
81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09-1.2
10 11 12 13
-5
Members’ preference for deleveraging and a weak economy will keep loan growth below its long-run
trend for the next few years. Balance sheet strength will be a high priority over the next few years, 4
outweighing balance sheet growth.
Net Income to Average Assets
160
137
139
140
120
121
104
113 110
97
98
Basis Points
100
92
102
102
94
94
89
93
95
107 104
95
85
90
82
80
80
68
64
60
39
40
18
20
0
86
88
90
92
94
96
98
00
02
04
06
-2
08
10
-20
12
Forecast
High-performing CUs are doing the following: clearly articulating the member value proposition for
each demographic segment, transforming the cost base, improving the credit portfolio, attracting more
core deposits, increasing fee income, improving the risk management culture and process, aligning the
operations to the strategy, improving methods to retain human capital.
Net Capital to Assets
12
11.511.4
11.4
11.110.9 11.0
10.9
10.910.9 11.1
10.8
10.6
10.5
10.3
9.6
10
10.6
10.2
9.9 10.1
11
9
7.9
Percent
8
6.4
6.7 6.5
83
85
6.2
6.5
8.1
7.5 7.6
6.8
6
4
2
0
87
89
91
93
95
U.S.
97
99
01
03
PCA Well Cap'd
05
07
09
11
13
Forecast
CUs are increasing their capital-to-asset ratios to absorb potential loan or asset losses. This will
reduce leverage ratios (asset-to-capital) and therefore reduce return on equity ratios for any given
return-on-asset ratio. This will reduce how fast CU assets can grow. Higher interest rates in “mid
2015” will reduce the value of investments and long-term loans and will cause other troubled assets 5to
appear. This will have a negative impact on capital ratios.
The Virtuous Cycle of Banking
Faster Asset Growth
Higher
Return on Equity
ROE
Economies of Scale
•Self-reinforcing spiral
•Feedback Loop
Higher
Return on Assets
ROA
Higher
Profit Margin
Capital-to-Assets Growth Rate Analysis
The growth rate of a ratio is the difference between
numerator and denominator growth rates, (for small
growth rates).
%D (C/A) = DC/C – DA/A
5%
growth
0.10 = 10 ========> 10.5 = 0.102
100
103
3%
growth
2%
growth
2% = 5% - 3%
If (ROE) DC/C = DA/A
Then %D (C/A) = 0
If DC/C = DA/A (multiply both sides by C/A)
Then ROA = DA/A x C/A
7
Return on Equity Decomposition
ROE = Asset Growth Speed Limit
(given a constant Capital-to-Asset ratio)
Return on
Equity
Leverage
Return on
Assets
R
A R 
A R
GR 






E
E A
E  GR
A 
Profit
Margin
R
E
A
GR
Asset
Utilization
= Return (net income)
= Equity (reserves + undivided earnings) (beginning of period)
= Assets (beginning of period)
= Gross Revenues (interest revenue + noninterest revenue)
Credit Union
Return on Equity
(by Asset Size)
16
14
12
10
8
6
4
2
0
-2
-4
-6
-8
-10
-12
< $100 Million
$100-$500 Million
> $500 Million
10.5
9.16
9.06
6.86
4.94
7.5
6.71
4.39
5.23
1.94 2.28
3.52
3.43
07
08
3.34
2.96
1.93
0.43
06
5.94
5.26
-1.42
09
0.42
10
11
Aphorism #1: If your financial institution is not growing, its dying.
Aphorism #2: ROE disparity is the current separating small and large financial institutions.
Economic Paradox: Recessions are good for an economy.
12
Credit Union
Equity Multiplier (Leverage)
(Assets to Equity)
(by Asset Size)
14
12
9.61
8.95
10
8
7.84
9.53
8.45
9.36
8.58
7.48
10.04
8.95
10.86
9.99
9.91
10.5
8.46
8.29
10.13
9.71
8.55
7.52
7.30
6
4
2
< $100 Million
$100-$500 Million
> $500 Million
0
06
07
08
09
10
11
12
NCUA 7% well capitalized requirement limits the maximum equity multiplier to 14.3.
Other Capital-to-Asset and Leverage combinations: 8% 12.5, 9% 11.1, 10% 10, 11% 9.1, 12% 8.3.
Credit Union
Return on Assets (basis points)
(by Asset Size)
200
180
160
140
120
100
80
60
40
20
0
-20
-40
-60
-80
-100
-120
-140
< $100 Million
$100-$500 Million
> $500 Million
104
95
63
77
59 61
86
72
69
27 27 36
35
5
06
07
08
09
33
61
53
35
23
5
10
11
12
-19
ROA is rising as loan loss provisions fall. This leads to faster capital growth which allows for organic loan
and savings growth. Additional capital allows for expanded in-market branch networks to control market
share. Credit unions can boost returns by better managing costs especially the ever rising technology9
costs. CUs are shifting more of their focus to online products and services as member preferences evolve.
Credit Union
Profit Margin
(Net Income to Gross Revenues)
(by Asset Size)
30
26
22
18
14
10
6
< $100 Million
> $500 Million
$100-$500 Million
19.74
9.5
11.2
15.5
13.4
11.5
8.2 8.3 9.4
4.0 3.8 4.9
06
07
08
-3.1
7.2
4.5
0.9
0.7
2
-2
-6
-10
-14
-18
-22
5.7
4.9
11.64
9.6
09
10
11
12
Profit margin is a measure/proxy for efficiency. Greater risk taking (asset utilization) may reduce profit
margins. This highlights the trade offs of any business decision.
The Great Recession is analogous to a forest fire; it eliminated the weak, inefficient and low
profitability firms, just like a fire consumes the small weak underbrush. Those firms and trees that
survive are more prosperous than before the recession or fire.
Credit Union
Asset Utilization
(Gross Revenues to Assets)
(by Asset Size)
8
7
6.6
6.86
7.12
7.2 7.38
7.61
7.16
7.4
6.79
6.7
7.09
6.1
6
5.5
5.85 5.99
5.53 5.57
5.1
5.26 5.25
4.8
5
4
3
2
1
< $100 Million
$100-$500 Million
> $500 Million
0
06
07
08
09
10
11
12
Asset utilization is a measure/proxy for the degree of risk taking (credit, interest rate and liquidity risk).
Utilization is down because of lower interest rates, higher delinquent loans, lower loan-to-savings 10
ratios, higher risk aversion, and lower fee income.
Asset-Liability Management Issues
Interest Rate Risk
Interest rate risk is the potential impact of interest rate movements on an institution’s
net interest income and capital level. It focuses on the repricing speed of the
institution’s assets relative to liabilities.
Issues:
•
Historically low interest rates
•
Relatively steep yield curves will put upward pressure on net interest margins if
loan can be made. Cost structure adjustments will boost net income.
•
Can only increase asset yields by taking substantial risk.
•
Large holdings of mortgages with a possibility of higher inflation and interest rates
in the future.
•
Rapid deposit growth will lower loan-to-savings ratio.
•
Changing asset mix from loans to investments.
•
Must align asset growth to earnings growth to maintain capital ratio.
•
Capital limitations will restrict pace of asset growth.
•
Optimal deposit pricing key to performance as financial institutions compete for
deposits.
Credit Risk
Credit risk is the oldest of all financial risks. It is the danger that a borrower will
simply fail to meet interest payments or repay a debt.
Issues:
•
High unemployment and falling home prices have elevated loan charge-offs.
•
With 20% of homeowners underwater with their mortgages, foreclosures will
remain high through 2012. Mortgage modifications is mainly delaying rather than
preventing foreclosures.
•
Financial institutions have rapidly increasing their allowance for loan loss account.
They have moved from a building phase to maintenance phase.
•
High loan loss provisions have pulled down net income.
•
Total loan growth will outpace delinquent loan growth, increasing delinquency
ratios.
Liquidity Risk
Liquidity risk is concerned with maintaining an adequate availability of funds for loan
demand, deposit outflows, and expense payments in changing interest rate
environments.
Issues:
Financial institutions are flush with low-rate excess reserves.
Deposit growth will outpace loan growth through 2012.
11
Rising investment-to-asset ratios will put downward pressure on asset yields.
Households will maintain high savings rates and deleveraging through 2012.
Provisions for loan Losses
Equilibrium Condition
Provisions = Net Charge-offs
Allowance for
Loan Losses
Net Charge-offs
$10
$9
$8
CU Provisions, Allowances &
Net Chargegoffs
($ Billions)
Provisions
Allowance for Loan Loss
Net Chargeoffs
$10
$9
$8
$7
$7
$6
$6
$5
$5
$4
$4
$3
$3
$2
$2
$1
$1
$0
$0
90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12
The allowance for loan loss (ALL) account is a credit union’s estimate of the dollar amount of bad
loans currently held on the balance sheet. Credit unions are reducing the ALL account by reducing12
loan
loss provisions below the rate of net chargeoffs.
Credit Union Credit Quality
(As a % of Loans)
2.2%
2.2%
Loan Loss Provisions
2.0%
Allowance for Loan Losses
2.0%
1.8%
Net Charge-offs
1.8%
1.6%
1.6%
1.4%
1.4%
1.2%
1.2%
1.0%
1.0%
0.8%
0.8%
0.6%
0.6%
0.4%
0.4%
0.2%
0.2%
0.0%
0.0%
04:1
05:1
06:1
07:1
08:1
09:1
10:1
11:1
12:1
Source: NCUA
CU Net Chargeoff Rates
(Loans Charged Off Net of Recoveries as a Percent of Average Loans)
1.40%
1.21%
1.14%
1.20%
1.00%
0.90%
0.84%
0.80%
0.70%
0.65%0.65%
0.60%
0.60%
0.59%0.59%
0.50%
0.49%
0.56%
0.53%0.54%
0.52%
0.49%
0.46%
0.45%
0.42%
0.50%
0.40%0.41%
0.40%
0.20%
0.00%
90
91
92
93
94
95
96
97
98
99
00
01
02
03
04
05
06
07
08
09
10
11
12
13
YOA vs 10-year Treasury Rate
1988-2012
10
10
9
9
8
8
7
7
6
6
5
5
4
4
3
3
2
2
1
1
0
Percent
11
Yield on Assets %
11
0
88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13
1.1% Spread
Yield on Assets
10- Year Treasury
Falling YOA to record low levels is due to: historically low interest rates, price competition for good loans, excess
liquidity, weak loan demand, low investment yields, deleveraging, debt aversion and abnormally high risk aversion.
COF vs Fed Funds Rate
1988-2012
10
9
9
8
8
7
7
6
6
5
5
4
4
3
3
2
2
1
1
0
0
88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13
Cost of Funds
Fed Funds
The Federal Reserve’s “exceptionally low interest rates for an extended period” is causing CU cost of funds, COF, to
14
asymptotically approach 0%.
Percent
Cost of Funds %
10
CU Net Interest Margin
1981-2012
540
540
Recession
Basis Points
520
NIM
520
500
500
480
480
460
460
440
440
420
420
400
400
380
360
380
DIDEMCA
1980
360
Interstate Banking
Act 1994
340
320
Garn-St. Germain
1982
300
340
320
Financial Modernization
Act 1999
300
280
280
81
83
85
87
89
91
93
95
97
99
01
03
05
07
09
11
13
Deregulation over the last 30 years has increased competition in the financial services arena, resulting in lower net interest
margins. Banking competition will increase as survivors of the Great Recession reduce their risk aversion. For an individual
CU, margins will also be determined by local market demographics: population growth, median household income, local
industry, age trends, etc.
Net Interest Margin vs
Operating Expense to Average Assets
425
425
408
398
400
392
397
394
389
391 393
386 385
377
371
375
Basis Points
400
381
358
375
361
350
338
356
350
325
321 338
318
316 333
331
330
314
312
326
310
325
331
339
325
332
329 331
323
319 319
317
314
300
307
306
301
335
325
319 320
305
316
298
309
275
300
275
88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13
NIM
Operating Expense
Net interest margins are falling as YOAs fall faster than COFs. Credit unions have been “underwater” for the last 8 years as
operating expenses have been greater than net interest margins. Mergers will accelerate as a means to reduce operating
15
expense ratios. Cost containment and reorganization efforts are also a high priority: enhance the distribution system, evaluate
the product menu, optimize business processes, improve vendor relationships.
Commercial Bank
Yield on Assets & Cost of Funds
10%
Yield on Assets
Cost of Funds
9%
8%
5%
4%
7%
6.1%
5.9%5.9%5.9%6.0%
5.9%
5.7%
5.5%
5.4%
5.3%
5.1%
5.0%
4.9%
4.7%
4.7%4.7%
4.5%4.4%4.5%
4.4%
4.3%
4.1%4.1%4.0%4.0%
4.1%4.0%
3.9%3.8%
3.8%3.7%
3.6%3.6%
3.5%
3%
6%
5%
4%
3%
2%
1%
9%
8%
7%
6%
10%
1.2%1.2%1.3%
0%
04:1
3.0%2.9%3.0%3.1%3.0%
2.9%
2.7%
2.5%
2.4%
2.2%
2.0%
2.0%1.8%
1.8%
1.6%
1.5%
1.2%1.1%
1.0%0.9%
0.8%0.8%
0.7%0.7%0.6%0.6%
0.6%0.5%0.5%0.5%
05:1
06:1
07:1
08:1
09:1
10:1
11:1
2%
1%
0%
12:1
Source: FDIC
YOA is at record low levels due to: historically low interest rates, price competition for good loans, excess liquidity, weak
loan demand, low investment yields and abnormally high risk aversion.
Commercial Bank
Net Interest Margin vs Operating Expense
4.0%
4.0%
3.8%
3.8%
3.6%
3.6%
3.4%
3.4%
3.2%
3.2%
3.0%
3.0%
2.8%
2.8%
2.6%
2.6%
2.4%
2.4%
Net Interest Margin
Operating Expense
2.2%
2.2%
2.0%
2.0%
04:1
05:1
06:1
07:1
08:1
09:1
10:1
11:1
12:1
Source: FDIC
Net interest margins are falling as YOAs fall faster than COFs. COFs are asymptotically approaching 0%.
The Great Recession led to over 400 bank failures which reduced capacity and improved margins in an overcrowded
market. Banking woes include anemic economic growth, piles of new regulation, waves of housing related litigation16
and
exposure to European banks and the Euro-zone debt crisis.
Commercial Bank
Loan Net Chargeoffs
4.0%
4.0%
Overall Net Chargeoffs
1-4 Family 1st Mortgage
3.5%
3.5%
C&I
Commercial Real Estate
3.0%
3.0%
2.5%
2.5%
2.0%
2.0%
1.5%
1.5%
1.0%
1.0%
0.5%
0.5%
0.0%
0.0%
04:1
05:1
06:1
07:1
08:1
09:1
10:1
11:1
12:1
Source: FDIC
High unemployment and falling property prices levied a heavy toll of bad debts. Credit quality has improved leading to
easier lending standards. Banks need to deal with the large amounts of distressed assets that remain on their balance sheets.
Commercial Bank
Loan Loss Provision & ROA
2.6%
2.4%
2.2%
2.6%
Return on As s ets
2.4%
2.2%
Loan Los s Provis ions
2.0%
2.0%
1.8%
1.8%
1.6%
1.4%
1.6%
1.4%
1.2%
1.2%
1.0%
0.8%
1.0%
0.8%
0.6%
0.6%
0.4%
0.4%
0.2%
0.0%
0.2%
0.0%
-0.2% 04:1
05:1
06:1
07:1
08:1
09:1
10:1
11:1
12:1
-0.2%
-0.4%
-0.4%
-0.6%
-0.8%
-0.6%
-0.8%
-1.0%
-1.0%
Source: FDIC
Falling provisions for loan loss has led to bank return on assets, ROA, to climb above 1% in the second quarter of 2012.
Bank capital ratios are now some of the highest in the world over 10%.
During the boom many banks boosted earnings simply by levering up, masking poor returns on assets with the magic of
debt.
New banking rules (BASEL 3) require banks to hold more capital (against potential losses) and bigger pools of liquid assets
and more long-term debt (if funding markets dry up) which will depress returns on equity. New bank regulation will make
17
banks safer at the cost of decreased supply of credit at a higher interest rate. Dodd Frank Act compliance costs will increase
operating expenses.
Quarterly % Change in U.S. Economic Output
(Real GDP - Chainweighted 2005$)
Below trend growth
•Falling stimulus spending
•Less inventory rebuilding
•Slowing Euro-Zone
•Financial crisis
•Deleveraging households
•Rising savings rates
10%
9%
Maximum Sustainable
Growth Rate = 3%
8%
7%
6%
5.1%
5%
4%
3%
4.2%
3.3%
3.0%
2.7%2.6%
3.2%
2.7%
1.8%
2%
2.1%
3.9%3.8%
3.8%
3.6%
3.0%
1.7%
1.6%
05:1
06:1
07:1
-2%
08:1
09:1
-0.7%
-1.8%
-6%
-7%
-8%
-9%
-10%
-3.7%
Falling Potential Growth Rate
•3.5% to 2.5%
•Less investment spending
•Lower leverage in post-credit era
•Suppressed demand
•Negative demographic trends
•Lower total factory productivity growth
2.0%
1.7%
10:1
11:01
12:01
13:01
Recession Factors:
-3%
-4%
2.5%2.5%
0.4%
0.1%
0%
-1% 04:1
-5%
1.8%
1.3%
1.7%
1.3%
0.5%
1%
3.5%3.5%3.5%3.5%
2.8%
2.5%2.3%
-6.7%
-8.9%
•Loose monetary policy
•Poor regulation
•Lax bank supervision
•Opaque derivatives
•Shadow banking system
•Lax investor diligence
•Poor governance
•Misaligned incentives
•fraud
Source: Department of Commerce.
The economic recovery continues, but is disappointing and is vulnerable to external shocks. GDP is back to its pre-recession
2007 peak. Final sales of domestic product – GDP minus change in inventories – grew 1.7% annualized. Inventories
subtracted 0.2% from growth as firms reduced the pace of inventory accumulation. Stronger aggregate demand will lead to
job growth, rising confidence and further spending (a self-sustaining expansion).
A Fiscal cliff may be approaching as the expiry of the Bush tax cuts and the pay-roll tax cut and the implementation of the
spending cuts scheduled under last falls sequestration could shave 3% off 2013 GDP growth.
Actual GDP is 5% below potential GDP.
A “balance sheet recession” is the process whereby households and companies pay down debts rather than embark on new
spending. The lack of demand for loans is due to the debt-strapped private sector.
Economic growth during 2002-08 relied too much on consumption spending and house buying, both financed by foreign
savings channeled through an undercapitalized financial system. Today’s sluggishness stems from pre-crisis excesses and
the misshaped economy it created. Recoveries from debt-driven busts always take years as households repair balance sheets.
2nd Quarter 2012 GDP
Spending = C + I + G + X – M
% of total = (70.6) (14.0) (18.5) (13.4) (-16.4)
Growth rate = (1.5) (8.5) (-1.4)
(5.3)
(6.0)
Contribution = (1.1) + (1.1) + (-0.3) + (0.7) + (-1.0) = 1.7%
(1+0.017)1/4 -1 = 0.0042 = 0.42%
18
US Payroll Employment
Thousands
Monthly Changes SA
600
600
500
500
400
400
300
300
200
200
100
100
0
0
-100 99
00
01
02
03
04
05
06
07
08
09
10
11
12
13
-100
-200
-200
-300
-300
-400
-400
-500
-500
-600
Recession
-600
-700
Payroll
-700
-800
150,000 Target
-800
-900
-900
Months of feeble job figures suggest America’s recovery may be in trouble. Payrolls increased 96,000 in August, with broadbased gains across many industries. This is below the 200,000 needed to meaningfully lower the unemployment rate. The
public sector remains a drag on payroll growth, Average workweek rose to 34.5. A greater workweek plus more payrolls lead
to 0.5% rise in total hours worked. Average hourly earnings ($23.31) rose by 0.3% m/m and 2.2% y/y, indicating little
evidence of wage pressures and below 3.0% inflation.
Forward looking indicators (temp hiring and average weekly hours) suggests additional hiring in coming months.
Unemployment Rate
18
17
16
15
(Percent)
14
18
17
Unemployed
Involuntarily working part-time
Marginally attached (want jobs but haven’t searched in a month)
16
15
14
13
13
12
12
11
11
10
10
9
9
8
8
7
7
6
6
5
5
4
3
2
1
Recession
Unemployment
4
Underemployment (U-6)
Full Employment (NAIRU)
2
0
3
1
0
80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13
Source: Department of Labor.
The unemployment rate fell to 8.1% in August, which corresponds to 12.8 million unemployed workers. Underemployment
rose to 14.9%. The labor force participation rate stayed at 63.8%. Employment-to-population ratio stayed at 58.6%.
The labor force rose 156,000: employed rose 128,000, unemployed rose 28,000.
Structural Unemployment Disease: Joblessness is becoming chronic with the average unemployment at 40 weeks. Longterm unemployment is harder to cure because workers’ skills atrophy (human capital degradation) and they become detached
from the work force. High long-term unemployment decreases future economic growth, raises future deficits and decreases
19
social order.
Unemployment Rate Vs
CU Delinquency Rate
12
2
11
1.75
10
9
1.5
8
(Percent)
1.25
7
6
1
5
0.75
4
3
0.5
2
0.25
1
0
0
90
91
92
93
94
95
96
97
98
99
00
01
02
03
04
05
06
Recession
Delinquency (RHS)
07
08
09
10
11
12
13
Unemployment (LHS)
Every 1 percentage point change in U.R => 0.19 change in delinquency rate
Credit Risk (2 types)
1. Default Risk – borrowers’ willingness and ability to repay debt
(unemployment rate)
2. Collateral Risk – market value decline of the asset securing the loan.
(home price changes)
Unemployment Rate
Versus
CU Net Chargeoff Rate
14%
13%
12%
11%
10%
9%
8%
7%
6%
5%
4%
3%
2%
1%
0%
Unemployment Rate (LHS)
Net Chargeoff Rate (RHS)
10.1%
9.6%
9.3%
9.7% 9.6%
9.5% 9.6%
9.1%
8.9% 9.0%
8.7%
8.3%
8.3%
6.9%
6.0%
5.3%
4.5% 4.5% 4.6%
07:1
4.8% 4.9%
08:1
09:1
10:1
11:1
1.4%
1.3%
1.2%
1.1%
1.0%
0.9%
0.8%
0.7%
0.6%
0.5%
0.4%
0.3%
0.2%
0.1%
0.0%
12:1
Source: Department of Labor, NCUA,CUNA
20
Every 1 percentage point change in U.R => 0.12 change in NCO
Consumer Price Index
1970 to Present
Annual Percentage Change
14
13
13.3
12.5
12.3
12
11
10
9.0
8.7
9
8
6.9
7
6
8.9
6.7
6.1
2.5% Target
5.6
4.9
5
4
3.83.84.0
3.8
3.33.4
4.7
4.44.4
3
1.71.6
2
4.1
3.33.5
2.5
2.4
1.9
1.6
3.4
2.6
3.3
3.12.9
2.72.72.5
3.0
2.8
1.4
1.7
1.1
1
0
-1
70
72
74
76
78
80
82
84
86
88
90
92
94
96
98
00
02
04
06
-0.1
08
10
12
August Data:
Inflation = 0.6% m/m, 1.7% y/y, (gain was due to rising gasoline prices)
Core inflation = 0.1% m/m, 1.9% y/y, (below Federal Reserve’s target)
Expect lower inflation in 2012 due to a lack of broad pricing power and the subdued economic recovery.
Lower inflation will boost real disposable income growth rates.
The recent deceleration in inflation was a factor pushing the Federal Reserve to implement another round of
quantitative easing “QE-3” (print money to buy assets)
Businesses are unlikely to slash prices (deflation) because inventories are lean.
Inflation (CPI)
(year over year % growth)
6%
5%
4%
3%
2%
1%
0%
95
96
97
98
99
00
01
02
03
04
05
06
07
08
09
10
11
12
13
-1%
-2%
-3%
Headline
Core (excludes food and energy)
Lower input and headline prices point to slower underlying inflation in the months ahead.
Fed doesn’t need to head for the exit yet (raise interest rates).
Fed needs to talk tough on inflation to keep expectations anchored.
Bond markets are not pricing in higher inflation. (Nominal – TIPS rates)
Surging import prices could dislodge inflation expectations.
Business are starting to pass through some input costs to the consumer.
Normally inflation is a welcome sign of a strong economy, but most of the inflation is cost push and not demand pull
Dollar depreciated 6% over last year => lagged impact on import prices
21
Interest Rates and Recessions
1988-2012
10
10
9
9
8
8
7
7
6
6
5
5
4
4
3
3
2
2
1
1
0
0
88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13
Recession
Baa
Fed Funds
10-yr Treas
The Federal Reserve has pushed down interest rates to discourage savings and boost consumer demand and to encourage
business borrowing, investment and employment. The Fed has forced the 10-year Treasury interest rate to the lowest in
history because of the incredibly weak economy. The low interest rate is a sign from the bond market that they expect years
of stagnation and deflation or are terrified of imminent danger.
Federal Reserve Policies:
1. Open market operations to increase banking system reserves and lower the fed funds interest rate to 0.0-0.25%.
2. QE (quantitative easing) creation of money to buy assets. This “credit easing” unclogs credit channels (ex. MBS) by
boosting liquidity and decreasing interest rates. Investors sell securities to the Fed and then invest proceeds in other
assets (portfolio rebalancing) which raises their prices. Lower interest rates increase borrowing and investment and
therefore economic growth. Rising stock prices increase consumption spending. Higher liquidity boosts foreign asset
prices, lowers the dollar’s value and increases exports. Lower interest rates decrease government borrowing costs and
the future taxation burden.
3. Intent – the Fed announced that is plans to keep short-term interest rates “exceptionally low for an extended period”.
According to the Expectations Theory of interest rates, this intent will bring down long-term interest rates.
4. Excess reserves interest rate is lowered to 0.25%.
5. Operation twist – selling short-term debt (less than 3 year maturity) to fund the purchase of long-term debt (greater
than 6 year maturity). This gives investors cash for long-term debt which should prompt them to invest more money in
other assets. Fed announced in the fall of 2011 they would sell $400 billion, and in June 2012 they would sell an
additional $267 billion. Operation twist ends at year end when short-term bonds are gone.
Federal Reserve Concerns:
Cost benefit analysis – do the uncertain risks of uncertain magnitude outweigh the benefits of doing more.
Diminishing returns – additional QE will have smaller effects on the real economy.
QE effects on the real economy - $600 billion of asset purchases => decline in long-term interest rates of 20 basis points.
This effect is equivalent to a 75 basis point reduction in the fed funds interest rate. This lowers the unemployment rate by
1.5 percentage point and raises economic growth by 0.3% versus the counterfactual.
Asset-Shortage Theory: U.S. Government bond yields are low because of a worldwide shortage of safe assets (MBSs and
PIIGS sovereign debt are no longer considered safe assets) and a glut of global savings (business parking surplus cash and
consumers savings more). Is the savings glut temporary? We could go from fretting about scarce assets to about scarce
capital and the accompanying rising interest rates.
Bond yields today are not a true “market price” since central banks are such big players in the market.
22
Asian central banks are helping to keep interest rates low as they recycle their foreign exchange reserves into government
bonds.
Existing Home Sales (annual rate)
& Inventories
8000
5000
4750
7500
4500
4250
6500
4000
6000
3750
3500
5500
3250
5000
3000
4500
2750
Thousands
Thousands
7000
2500
4000
2250
3500
2000
3000
1750
95
96
97
98
99
00
01
02
03
04
Recession
05
06
07
08
Sales (LHS)
09
10
11
12
13
Inventories (RHS)
Real interest rates are the major driver of housing demand. Real interest rates are measured by the gap between
average mortgage rate and annual wage growth. Real interest rates have fallen sharply in America to a 24 year low.
The Housing Market in July
•
4.47 million annualized units sold, up 2.3% m/m, up 10% y/y.
•
Sales are moving in the right direction.
•
Median home price was $187,300, up 2.1% m/m, up 9.4% y/y.
•
Months supply of homes = 6.4
Demand side factors:
1.
Low mortgage interest rates, but tight credit
2.
Rising consumer confidence
3.
Modest job and income growth.
Supply-side factors:
1.
Expect home prices to fall again in 2013, as foreclosed property eventually enters the market (shadow inventory)
and adds to supply overhang.
2.
Falling inventory of homes
Median Existing Home Price
& Months Supply at Current Sales Rate
14
13
12
11
10
9
8
7
6
5
4
3
2
$250
$240
$230
$220
$210
$200
$190
$180
$170
$160
$150
03
04
05
06
07
08
09
Home Prices (LHS)
10
11
12
13
23
Months Supply (RHS)
Household Debt
(As a Percent of Disposable Household Income)
140%
140%
130%
130%
120%
120%
110%
110%
100%
100%
90%
90%
80%
80%
70%
70%
60%
60%
50%
50%
40%
40%
79
82
85
88
91
94
97
00
03
06
09
12
Source: BEA & Federal Reserve.
The debt-to-income ratio is falling because a lot of mortgage debt has been written off
and new debt is hard to get. Consumers are also deleveraging to work off this mountain
of debt. The debt-to-income ratio reached 1.09% in Q1, 2012, down from 1.29% in Q3
2007. Economists believe a ratio of 100% is sustainable in the long run.
The Great Recession has led to a fundamental attitude shift regarding debt.
The benign macroeconomic environment of the past two decades masked a buildup of
financial instability; it may also have been storing up the elements of prolonged social
discontent.
The “De” Era
Debt => Deleveraging => Deflation => Defaults => Depression
Some households may be experiencing rising real debt burden (Debt/Income)
 wages, hours, prices, profits =>  income =>  real debt burden
Rising real debt burden (Debt/Income)
=>  spending to service debts => slower economy
Or
=>  defaults => weaker financial system => slower economy
Source: Flow of Funds, D.3 Debt Outstanding By Sector, Total Household .
BEA, Disposable Personal Income, $ billions.
24
Taxmageddon
$600 Billion in Tax Increases and Spending Cuts
Assuming President/Congress does not act
Tax Policy Expiring on 1/1/13
Tax Increase
(Billions)
Bush tax cuts
$166
Payroll tax cut
$125
Alternative minimum tax patch
$119
Tax cuts from 2009 stimulus
$21
Tax extenders
$21
Death tax at 35 percent with $5 million
exemption
$13
100 percent expensing of business
investment
$8
Tax Policy Beginning on 1/1/13
Tax hike in Obamacare
$23
Automatic Spending Cuts
Budget Control Act - 2013
$100
$600 Billion = 4% of a $15.5 Trillion Economy!
CUNA’s Economic and Credit Union
2012-2013 Forecast
As of July 2012
ECONOMIC FORECAST
•
•
•
•
•
•
The U.S. economy is expected to grow 2% in 2012 and 2.5 in 2013. The economic recovery
continues but is disappointing and is vulnerable to external shocks. Uncertainty related to the Eurozone debt crisis and the year-end U.S. fiscal cliff is causing many businesses and consumers to delay
purchases and hoard cash. Three months of feeble job gains suggests the recovery may be in
trouble.
Inflation will fall below the Federal Reserve’s inflation target of 2% in 2012 and 2013. Core
inflation (excluding food and energy prices) will also fall below 2% in 2013 due to a slowing economy
and falling commodity prices. Low core inflation will keep inflation expectations low and therefore
also keep long-term interest rates low.
The unemployment rate will slowly decline over the next two years. The unemployment rate will
decline as employers increase hiring faster than new entrants coming into the labor force. The
higher than normal unemployment rate will keep loan delinquency rates above historical averages.
The fed funds interest rate will stay in the 0-0.25% range through 2013 due to weak economic
performance. Labor and credit market conditions will be the major factors influencing the Federal
Reserve’s decision to raise interest rates. The Federal Reserve will wait until loan demand picks up
and the unemployment rate falls before beginning its exit strategy from its extraordinarily easy
monetary policy.
The 10-year Treasury interest rate will average 1.9% in 2012 and 2.25% in 2013. Ben Bernanke will
keep his foot on the monetary accelerator to keep downward pressure on long term interest rates
through 2013. Long-term interest rates are likely to climb over 2.5% by the end of 2013.
The Treasury yield curve will steepen in 2012 and 2013 as long-term interest rates rise faster than
short-term interest rates. This may increase credit union’s net interest margins as borrowing short
term and lending long term becomes more lucrative; but only if loan demand is there.
CREDIT UNION FORECAST
•
•
•
•
•
Credit union savings balances are expected to grow 6% in 2012 and 5% in 2013. Falling consumer
confidence and rising economic uncertainty will increase savings balance growth in 2012 relative to
2011. Many members are paying off debt rather than save any additional surplus funds due to the
large interest rate differential between loan and deposit interest rates.
After 3 years of basically no loan growth, we expect credit union loan balances to rise 3% in 2012
and 5% in 2013. A weaker job market will keep consumer confidence weak in 2012. But we expect
households to release some pent up demand for autos, furniture and appliances with an increase in
spending. Auto loans, credit card loans and purchase mortgage loans will be strong growth areas.
Credit quality will improve in 2012 and 2013. Overall loan delinquency and charge-off rates will fall
as job growth continues. Provisions for loan losses as a percent of assets will fall to 0.40 percent in
2012, below the 0.43% recorded in 2007.
Credit union return on assets will rise to 0.80% in 2012 and 2013. Lower loan loss provisions will
boost net income in 2012 as CUs allow their allowance for loan loss accounts to decline. We expect
NCUA assessments to come in at 10 basis points of insured shares in 2012.
Capital-to-asset ratios will rise to 10.8% in 2013. Credit union capital ratios will approach the
record level of 11.5% set in 2006, the year before the beginning of the great recession.
26
Economic Forecast
July, 2012
Actual Results
5Yr Avg 2011
Growth rates:
*Economic Growth (% chg GDP)
Inflation (% chg CPI)
Core Inflation (ex. food & energy)
Unemployment Rate
Fed Funds Rate
10-Year Treasury Rate
0.56%
2.24%
1.76%
7.66%
1.45%
3.46%
Quarterly Results/Forecasts
2012:1
2012:2
2012:3
2012:4
1.70%
3.00%
2.20%
8.93%
0.10%
2.66%
1.90%
1.75%
2.00%
2.25%
8.30%
0.10%
2.03%
8.20%
0.10%
1.81%
8.00%
0.10%
1.75%
7.90%
0.10%
2.00%
Annual Forecasts
2012
2013
1.98%
1.75%
2.00%
8.10%
0.10%
1.90%
2.50%
1.75%
1.75%
7.75%
0.10%
2.25%
* Percent change, annual rate
All other numbers are averages for the period
Credit Union Forecast
July, 2012
Actual Results
5Yr Avg 2011
Growth rates:
Savings growth
Loan growth
Asset growth
Membership growth
Quarterly Results/Forecasts
Annual Forecasts
2012:1
2012:2 2012:3
2012:4 2012
2013
6.4%
3.0%
6.0%
1.3%
5.2%
1.1%
5.1%
1.4%
4.7%
0.0%
4.1%
0.7%
0.5%
1.5%
0.8%
0.7%
0.1%
1.1%
0.1%
0.6%
Liquidity:
Loan-to-share ratio**
76.9%
69.2%
66.1%
66.8%
Asset quality:
Delinquency rate
Net chargeoff rate*
1.50%
0.92%
1.60%
0.91%
1.51%
0.79%
Earnings
Return on average assets (ROA)* 0.46%
0.68%
Capital adequacy:
Net worth ratio**
10.2%
10.5%
0.7%
0.4%
0.6%
0.2%
6.0%
3.0%
5.6%
2.2%
5.0%
5.0%
4.8%
2.0%
67.5%
67.2% 67.2%
67.2%
1.40%
0.75%
1.30%
0.70%
1.20% 1.35%
0.70% 0.74%
1.00%
0.65%
0.80%
0.80%
0.80%
0.80% 0.80%
0.90%
9.9%
10.1%
10.3%
10.5% 10.5%
10.8%
* Annualized Quarterly Data
**End of period ratio
See also our MCUE website
If you have any questions or comments send an email to srick@cuna.coop
27
Corporate Resolution
Cost Detail
2012 Update
Range = $2.2 Range = $4.3 Range = $3.3
Midpoint = $15.0
Midpoint = $13.0
Midpoint = $13.3
$11.6 to
$14.9 Billion
$5.6 Billion
$6.0 to $9.3
Billion
2012 = $0.8 bil
Total= $3.3 + 0.8
= $4.1
$1.9 to $5.2
Billion
(Midpoint $3.6
Billion)
Source: CUNA-annotated NCUA table with 2012 update added by CUNA.
Corporate Stabilization Assessments
Billions of dollars
$2.5
ACTUALS
$1.96
$2.0
CUNA PROJECTIONS
Based on:
•
$3.6 billion midpoint (could be higher or
lower!)
• NCUA desire to finish the job sooner
rather than later
• Straight-line assessments in bp of
insured shares
$1.5
$1.00
$1.0
$0.78
$0.66 $0.69
$0.80
$0.76
$0.72
$0.5
$0.30
$0.0
2009 2010 2011 2012
2013 2014 2015 2106 2017
Corporate Stabilization Assessments
Basis Points of Insured Shares
CUNA PROJECTIONS
Based on:
• $3.6 billion midpoint (could be higher or lower!)
• NCUA desire to finish the job sooner rather than later
• Straight-line assessments in bp of insured shares
30
25.1
25
ACTUALS
20
15
13.4
9.5
10
7.5
5
7.5
7.5
7.5
7.5
4.0
0
2009 2010 2011 2012
2013 2014 2015 2106 2017