Are Credit Unions Heading Toward A Liquidity Crisis?

Sluggish share growth, record loan demand, and mounting unrealized losses on investment securities are putting pressure on liquidity across the industry.

The pandemic brought a flood of deposits to credit unions. Unprecedented federal relief packages left many members flush with excess cash while quarantines and shelter-in-place orders reduced consumer spending. Data from September 2022, two-and-a-half years after the pandemic began, shows a much different savings environment.

In the second half of 2022, members used excess cash to cover consumer goods made more expensive by inflation. According to the Federal Reserve, Americans saved only 2.4% of their disposable income in September. That’s down significantly from the double-digit savings rates of 2020 and early 2021.

Borrowing, however, was strong. Annual loan growth for the credit union industry reached a record high 19.1% as of Sept. 31, almost triple the share growth recorded. Stronger long growth coupled with weaker share growth pushed up the industry’s loan-to-share ratio to 78.3%, the highest since the pandemic began.

Loans And Shares

Despite rising rates, loan demand — at least in dollar terms — was robust through the first three quarters of 2022. It was high asset prices, however, that helped drive up those loan balances. As far as the number of loans, first mortgage origination activity slowed as the undeniably hot real estate market priced out many members. Second mortgages and HELOCs, on the other hand, surged as members tapped into their home equity.

As loan balances increased, the rising cost of goods forced consumers to further dip into their deposit accounts. Prices for groceries, gas, and rent have spiked, and pandemic federal aid is no longer available. Both of these factors have contributed to stunted share growth. However, keep in mind, abnormally high share growth in 2020 and 2021 might make future growth appear artificially sluggish.

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Annual loan and share growth have moved in opposite directions since the first quarter of 2021, with loan growth reaching a record 19.1% in the third quarter.

As of Sept. 30, the Fed had raised its benchmark rate 300 basis points in 2022. In the third quarter alone, the Fed raised rates 150 basis points. The industry’s cost of funds, however, increased only 5 basis points.

Excess liquidity from the pandemic has allowed credit unions to hold off on raising rates on deposits, but that liquidity dynamic might be starting to change. Some credit unions have turned to third-party channels to raise funds, and borrowing costs were the main driver behind the mild rise in the cost of funds in the middle half of 2022.

Interest paid on borrowed money tripled from the first quarter, while interest paid on deposits increased a more modest 32.8% during the same period. There are early signs that liquidity, or lack thereof, is becoming an industrywide concern.

Deposit Rates At Big Banks

According to the Wall Street Journal, Americans could have earned an extra $42 billion in interest in the third quarter alone by moving their savings from the five largest banks to the top high-yield savings accounts available elsewhere. This disparity is the largest for any quarter since tracking began. When fourth quarter data becomes available, that gap likely will be more drastic.

People like the big banks for convenience and ease. During a decade of prosperous economic times, opening a new account for an extra few hundred dollars a year in interest wasn’t worth it. However, those dynamics might change if economic pressures push more Americans to value financial benefits above convenience.

The average rate paid on savings accounts at the five largest banks has averaged 0.02% during the past eight years. Customers are used to getting paid nothing for their money. However, a rising Fed funds rate means the disparity between big banks and high-yield savings accounts is likely to widen. In the event of a recession, the extra interest earned by switching savings accounts might be worth it for Americans pinched by higher bills.

Credit unions should keep these factors in mind if liquidity concerns increase. For cooperatives struggling with liquidity, one potential solution is to compete for deposit market share by offering rates higher than their big-bank competitors. By investing in convenient technology and promoting the credit union difference, credit unions can help consumers overcome the psychological barriers of making a financial institution change.

The Investment Portfolio’s Impact On Liquidity

The investment portfolio is one of the largest factors impacting liquidity. The ICE BofA US Broad Market fixed income index returned -14.68% year-to-date through September. These losses have shown up in credit union investment portfolios in the form of unrealized losses on available-for-sale securities, which totaled $39.7 billion through September.

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Fixed income markets suffered historic losses in 2022, leading to mounting unrealized losses for credit unions.

The downturn in the bond market came after credit unions held a historically high percentage of their assets in investment securities, a side effect of repurposing excess cash from pandemic-era deposits to chase higher yielding investments. As securities mature, these unrealized losses will evaporate. However, for this to play out, the securities must reach maturity, which impacts liquidity.

To avoid selling and realizing losses, credit unions used cash balances to fund loans. However, cash is starting to dry up. As of Sept. 30, it was down 17.1% quarter-over-quarter and nearly half what it was at its peak in March 2021. At the end of the third quarter, cash comprised only 7.1% of credit union assets compared to 13.0% one year earlier. A prolonged downturn in the bond market and a slower flow of deposits could put more strain on cash balances, and credit unions will eventually have to find other sources of funds.

More Credit Card Loans Coming?

Credit card loan balances remained low during the pandemic but grew 14.1% year-over-year in the third quarter. Industrywide utilization increased 96 basis points annually and will likely increase further if the savings rate remains low and members need to draw on these lines of credit.

Unfunded commitments on credit card lines reached $188.9 billion in the third quarter. If utilization reaches its pre-pandemic level again, that will mean an extra $10.4 billion in loan balances if credit unions hold lines of credit constant, putting more pressure on liquidity for cooperatives that offer credit cards.

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Utilization bottomed at 26.1% in the second quarter of 2021. It was down from 31.2% before the pandemic began.

Costly Borrowing

Total borrowings at credit unions reached $81.7 billion in the third quarter, nearly double one year earlier. As a percentage of assets, borrowings were back to their pre-pandemic level. The increase in borrowing correlates to the rise in unrealized losses on investment securities, which picked up steam beginning in the first quarter of 2022. If credit unions don’t want to sell investments and they can’t attract more deposits, they have to borrow — and borrowing is costly.

Whether directly or indirectly, the Fed’s interest rate movements and the resulting consequences are the most impactful macroeconomic forces on credit union earnings and liquidity, and the Fed predicts higher rates will bring pain to households and businesses. As such, credit unions should consider what higher unemployment among members would mean for saving and lending activity and the resulting impact on industry liquidity.


January 23, 2023

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