In order to write this, four people are currently holding my head to keep it from spinning. The pace of new information and real volatility in global financial markets is simply dizzying and even nauseating. I'll attempt to provide some perspective and guidance here at the risk of everything changing by the time you get to read this.
Libor rates are way out of whack. When global banks cut rates (including 50 basis points by the U.S. Federal Open Market Committee) in a coordinated fashion this month, Libor actually went up. This global money interbank lending rate shows that banks don't trust each other enough to lend to each other. Liquidity provided by central banks simply sticks to the arteries of the banks' balance sheets–it is not moving into any type of lending activity. Banks are concerned about deposit runs and adding bad mortgage loans that cannot be refinanced.
The good news is that credit unions have no competition. Prime borrowers are coming to credit unions in droves after being denied credit at reasonable rates at the banks. The bad news is that the marginal cost of funding those loans has increased dramatically.
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What should CUs do? Dollar-cost average your loans into this marketplace. If you make every loan demanded of you in the next few months, you may run out of liquidity to fund loans in future periods. This can expose you to investing a lot of your balance sheet into one quarter's worth of loans. If the performance on those loans weakens due to a recessionary economy, it's easy to run into trouble one to two years down the road. It also exposes you to long-term interest rate risk.
Many of the government intervention actions may prove to be inflationary, meaning long-term interest rates would move higher. This puts the value of the current loans underwater. We are back to Banking 101, where loans grow at the pace of deposit growth. I don't think your recent competition (banks, mortgage brokers) is coming back in force for a long period, maybe five years. This will allow for you to look for consistent growth over time with less margin pressure.
However, the employment situation is bleak, and the consumer is under immense stress.
Job losses have been steady and the unemployment rate has moved above 6%. This was before many of the high-paying Wall Street and bank jobs got axed.
Consumer credit fell $7.9 billion in the last monthly reading, the biggest drop ever–the consumer is going into a shell. Stocks and home wealth have dropped dramatically.
Obviously, we are in a recession. It will likely be deeper and longer than any in the last 20 years. This will have a crushing effect on consumer psychology, as many have never experienced conditions like these in their working lives.
The impact on credit unions could be that delinquencies and charge-offs may increase as job losses increase.
Credit unions should continue to underwrite conservatively with an eye toward a scenario of high national unemployment rates, potentially reaching 8.5% to 9%. Your local economy will drive many of these decisions, but it's worth the time to understand the linkages between the national and global economic picture.
Inflation is not a problem in the immediate short run but may be nasty two to three years out. Oil and other commodity prices are reflecting an outlook for a widespread global recession. This will allow central banks cover to keep interest rates low for the next one to two years.
Credit union impact: short-term investment yields will likely be relatively low, around 1% to 3%, negatively effecting interest income. Current loan yields will look attractive. If inflation is a monetary phenomenon as I've been taught, the billions of dollars unleashed by central banks will likely cause future inflation. This means higher short-term rates could reach 5% to 6%, while long-term rates could rise to 8% to 10%.
To respond to this, credit unions should dollar-cost average your loans into this marketplace. Fight the impulse to stretch investment dollars past three years at current yield levels.
Mark A. Schieffer is executive vice president/chief investment officer for SunCorp. He can be reached at 877-786-2677 [email protected]
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