Consumers have been socking away much more in savings since the start of the COVID-19 pandemic, and that is putting pressure on credit unions’ ability to maintain capital at required levels.
Total U.S. shares — deposits that also convey partial ownership in the credit union — rose 14.8% year over year to $1.71 trillion in the second quarter of 2021, according to data from the National Credit Union Administration.
Those shares ideally are used to fund loans. Since loan demand is lagging, credit unions often have to put excess deposits into lower-yielding investments including federal funds, said Tim Scholten, president of the credit union and community bank consultancy Visible Progress.
Either way, loans and investments have to be offset with capital, according to Scholten. But credit unions have fewer options than banks when they need more capital — they can rely only on earnings.
The low-yielding investments are squeezing credit unions’ earnings and ultimately their net worth ratio, which is calculated by dividing assets into retained earnings.
A net worth ratio of 7% or higher represents a "well capitalized" credit union, according to the NCUA. At 6%, the credit union is "adequately capitalized."
If the net worth ratio drops below 7%, the institution will need to transfer a portion of its net income to statutory reserves instead of it all going to undivided earnings. Below 6% is where it gets more serious, and credit unions have to develop net worth restoration plans and face increased regulatory scrutiny.
“It’s a Catch-22 trend that hasn’t existed in a long time,” Scholten said of the challenge created by the wealth of deposits.
How credit unions are coping
North Country Federal Credit Union in South Burlington, Vermont, had $762 million in deposits as of June 30, up 14.6% from a year earlier. Bob Morgan, CEO of the $850 million-asset institution, said he expected it to end the third quarter with year-over-year share growth of 12% to 13%.
Morgan said that while that may not seem overly significant coming after last year’s growth above 20%, it is problematic and has caused net worth at North Country to decline from just above 10% in December 2019 to about 8.6% today, Morgan said.
“We’re still well capitalized, but it's a notable decline nonetheless,” he said. “The reality is neither earnings nor loan growth has matched the pace of deposit growth.”
North Country has kept the majority of the excess liquidity in overnight funds. It is assessing whether the new deposits will be sticky as consumers regain confidence in the economy, he said.
Some credit unions are using excess deposits to buy certificates of deposit that pay about 2% interest rather than using them to fund loans that could garner more than double that rate because the demand simply isn’t there, according to Scholten.
Credit union margins "are getting squeezed pretty hard,” Scholten said. “It’s hard to tell customers you don’t want their money, but eventually they have to say no to certain large deposits.”
The threat of inflation in the fourth quarter will slow deposit growth somewhat because consumers will need more of their income to pay for everyday goods and services. “But that alone will not solve the pressure on capital,” Scholten said.
So the most logical approach is to control growth to manage the interest rates paid for deposits. The lower asset growth rate and slight improvements to net interest margin that result could take some of the pressure off capital ratios.
“My approach is pretty fundamental, but capital is always a growth constraint in this business,” Scholten said.
Truliant Federal Credit Union in Winston-Salem, North Carolina, had $3.2 billion in shares as of June 30, compared with $2.8 billion a year earlier.
Todd Hall, president and CEO of the $3.5 billion-asset credit union, said its annualized first-quarter deposit growth rate exceeded 30%, and strong growth continued through the second quarter.
“We expect that much of this boost in deposits will stay with us, allowing Truliant to be opportunistic about how we manage our assets,” Hall said.
Loan growth has been strong over the past several quarters for Truliant, driven by member business lending, mortgage lending and consumer lending. The credit union has also increased the size of its investment portfolio, focusing on highly liquid fixed-income securities while avoiding credit risk.
“Our prudently allocated investment portfolio carries a lower yield than our loan book, but we see opportunity in the ability to transfer assets from investments to loans in the future when the economic cycle drives loan demand in excess of deposit growth,” Hall said.
Truliant has also devoted some of its deposit growth to paying off borrowed funds, while maintaining the ability to borrow again in the future when conditions warrant it, Hall said.
And there are signs that members’ desire to save is slowing.
Signs of recovery?
The growth rate for shares across the industry fell from 23.1% in the first quarter of the year to 15% in the most recent quarter. That rate is still above normal, but the dip is a good first step, said Curt Long, vice president of research for the National Association of Federally-Insured Credit Unions.
“Credit union net worth rebounded in the second quarter,” Long said. “There are a number of positive industry trends at the moment, highlighted by moderating share growth, increasing member growth and rock-solid loan performance.”
The problem is much the same for banks, although they have more options for raising capital. Deposits totaled more than $17.2 trillion at the end of the second quarter, up nearly 11% from a year earlier, according to the Federal Deposit Insurance Corp.
And many banks are sitting on a lot of cash, Scholten said. One of his bank clients has at least 10% of its total assets sitting in fed funds, which are earning roughly a quarter of a percent in interest, he said.
Shane London, president and CEO of the $891 million-asset Deseret First Credit Union in West Valley City, Utah, said the credit union had a significant number of members who saved their stimulus proceeds, leading to elevated share levels.
Deseret First had $815 million in shares as of June 30, up 11.7% from a year earlier.
There was a spending uptick in the summer months, but the delta variant of the coronavirus may be responsible for some slowdown in spending the past month or so. Supply-chain shortages and inflation-led price increases may also be curtailing spending, London said.
The credit union anticipates that savings growth may range from 10% to 12% in the next year, but any further restrictions or economic events may push those numbers up.
“Consumers will eventually spend again and deposits may actually leave,” London said. “How long that will be is anyone’s guess. Net worth ratios have been impacted by the excessive deposit growth, but if consumers spend, the net worth downward pressure should reverse.”
Scholten said the glut of shares is an emerging problem and one that likely will not be going away anytime soon.
“If a credit union hasn't dealt with this yet, they will in the future,” he said.
