Prior to the Coronavirus expectations were for a gradual economic slowdown in 2020, but most economists were not expecting a full-blown recession. The abruptness and severity of the economic impact of the Coronavirus have been unprecedented, to say the least. First-quarter estimates of economic contraction are around a seasonally adjusted 5% annualized rate. Some second-quarter estimates range around a massive 20% contraction. Estimates of the unemployment peak in the near-term range widely from 15% to as high as 30%. However, a lot of uncertainties come in the months and quarters following the first half of 2020. Will the recovery be a “V”, “U”, or “L” shape is often the question asked? Some economists are expecting anywhere from an 8% to 12% annualized GDP growth rate bounce back in the second half of 2020 and some degree of bounce back is certainly likely. The very large uncertainty lies in how much that bounce back will be and how constant it will be in terms of the economy returning to positive growth on a sustained basis. For example, the unemployment rate will certainly come down substantially from its Coronavirus peak, but it is difficult to forecast to what level it will return. The days of sub 4.0% unemployment are gone and for the medium-term, the unemployment rate could settle in the high single digits. Unfortunately, many jobs and businesses will not be able to return and the pace that larger company job losses come back may be questionable for some industries. New jobs and areas of growth will certainly emerge, but it will take time. In considering the economic outlook, the credit union may want to contemplate several scenarios such as a quick bounce back in the second half of 2020, a more gradual and drawn out improvement after some initial bounce back, and a worst-case scenario where improvements happen slowly over a longer time period. Unfortunately, given the high degree of uncertainty at the current time, it may be prudent to plan for the latter two. From a risk management perspective, this means that credit unions should look hard at credit, liquidity, net interest income, and capital stress scenarios and plan accordingly.
Forecasting credit performance going forward will be challenging to say the least. As unemployment rates rise to unprecedented highs in the near term, recent legislation allows credit unions to enact forbearance programs for those members affected economically by the Coronavirus. Also, the legislation does not require a troubled debt restructuring (TDR) status for these loan modifications. Given the immediate and lasting economic uncertainties along with government policy reactions, determining actual future losses will be challenging for credit unions. Credit models generally are challenged with the uncertainties of government policy reactions. One possibility would be to consider different economic distress scenarios and be aware and prepared for the most severe that has a material probability of occurring.
During the last financial crisis and recession, credit unions generally experienced member share growth and even an acceleration of share growth at certain times. However, can we be certain this will be the case again? Various liquidity drivers impacting the balance sheet should be considered. For example, as opposed to share growth continuing unabated, what if members have a greater reliance on using savings to pay expenses. In addition, lower interest rates generally mean faster real estate prepayment rates, however, this will be offset by loan forbearance programs and the possibility of some members needing short term loans. As this is a vastly different crisis that may have a longer, more drawn-out lasting impact, the credit union should be on a heightened liquidity risk assessment and management alert.
From 2016 through 2018 the Federal Reserve gradually increased the federal funds rate and the U.S. Treasury yield curve also increased. Credit Unions began to see net interest income increase as balance sheets grew and margins expanded. However, during those later years, the U.S. Treasury yield curve began to flatten and even invert at times. During the second half of 2019, the Federal Reserve decreased the federal funds rate 75 basis points and many credit unions began to see net interest margin pressures emerge in the fourth quarter of 2019. With the onset of the Coronavirus crisis, the federal funds rate was swiftly taken to zero and the U.S. Treasury yield curve was well below 1.00% out to a 10-year term at the end of the first quarter. Net interest income will continue to be under pressure again due to a lower interest rate environment and possibly lower or even negative loan growth for some credit unions. Base case expectations for net interest income pressures should be assessed, but also the possibility of further pressures such as a lower level of loan growth or even negative loan growth stress scenarios.
Risk management is a function of credit union management and the need for risk management is heightened with such a high level of uncertainties and potential for adverse outcomes. Base case and stress scenarios allow the credit union the ability to assess the impact on capital and plan accordingly. Through all of this, keep in mind that it’s times like these where the credit union can show members their value by supporting them through financial challenges. Times like these can present the credit union with the opportunity to step up support for members with actions such as loan forbearance and small-dollar lending programs. Risk management is a function of credit union management and needs to be heightened during these times, but it is ultimately done to provide the best service to members and particularly in their time of need.