Economist: Prepare Now For Decline in 1% Avg. Earnings

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The sun rises. The Boston Red Sox are cursed. And a credit union's earnings should be about 1%.

That no-news-is-good-news axiom has never been more true than on that first one. It turns out that No. 2's guarantee wasn't so ironclad after all. And No.2's fate should prepare credit unions for a change in that third decree, as well, according to one person.

CUNA Economist Mike Schenk said he has been spending some time of late preparing credit union board members for what will almost certainly be an inevitable change in the bottom line. CUNA's economic forecast for the two years ahead indicates that earnings this year, on average, for credit unions will be right around .85%, and that that average will further decline to approximately .80% in 2006. "It will be well below the 1% average that everyone has been so used to," he said.

Schenk acknowledged that boards that don't hear his message could make life lousy for their CEOs.

Schenk offered his forecast most recently before the 2005 CEO Summit in Key West, Fla., which was hosted by a number of Midltantic-state leagues. He sagely prefaced his remarks, incidentally, by observing, "We have to talk about the economy today. Luckily, it's overcast. That always helps."

That credit union earnings will decline, on average, may surprise many CEOs who have noticed CUNA and others are projecting decent growth in several of the areas that drive that bottom line. The trade group is forecasting savings growth of 6% this year and 7% in 2006. Moreover, it expects loan growth will remain strong, growing 10% this year, and declining slightly to 9% in 2006. From that, CUNA is projecting the bellweather loan-to-share ratio will rise to 78.5% in 2005 and a slightly better 80% in 2006.

The reason, he said, can be found in the historical trends, and as everyone knows, put an economist on a deserted isle with books of economic trend data, and he has all he needs.

Coming out of recessions, Schenk pointed out, credit unions tend to make a lot of money. But as economy improves, credit union net income tends to shrink. "We think that credit union savings are going to start to take off in a fairly big way," said Schenk. "Now it's around 5%. As rates come from their bottom and start to come up, usually, savings growth continues to decline for a period of time. That's because people think rates are going to go higher yet, even as you're raising rates. And then it takes off. Where are we today? Rates are starting to rise, but we think it's going to increase fairly substantially."

He noted a number of major commercial banks have been very aggressive in pricing deposits, seeking to lock consumers in now before the rest of the market starts bidding up rates.

What happens to loans? "Exactly the opposite," noted Schenk. "Maybe it's a get-while-the-getting's-good phenomenon. Rates are going up. we think loan growth will continue for a while, and then drop off."

And there, as they say, it is in a nutshell (where you usually find nuts). CUs should prepare to start paying more for funds at the same time loan volume cools.

CUNA is projecting the yield curve to be lower than in years past. The current spread between Fed Funds and the 10-year Treasury is around 1.91%, and should grow to 2.0% by year-end 2005 before sinking to an average 1.25% by 2006. "The marginal net effect is going to be great for many credit unions," he said.

Schenk said it is CUNA's view the economy is in sustained recovery and it will continue for the next several years. Inflation will remain fairly tame, he predicted, but the job market will not improve markedly.

But he also said there is some "stuff that makes us think twice" in the projections. Among them is the federal deficit. Another is just how long consumers can continue to pile on debt: the percentage of household debt has gone from 65% of disposible household income in 1980 to 120% in 2004. "That makes us nervous," said Schenk. "It's true that people do have lower payments in many cases, but there are a lot more payments."

Another of the big "if's" has to do with appreciating home values. "If the mortgage bubble pops that will be really, really bad news and that loud noise you hear will be people dropping their keys on your desk."

Shenk said it is his view that credit unions have not overly loaded up on mortgages and do not have inordinate interest rate risk. "If anything, I think I would have advised credit unions to add more mortgages in that low loan rate environment," he said.

And he added he believes there's good news for smaller credit unions that have suffered from not offering mortgages. As refi's slow, members will turn back to their credit unions for other loan products.

But not enough to push earnings at most CUs to 1%.

Frank J. Diekmann is editor of The Credit Union Journal.

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