Will A Shift In Long-Term Borrowing Capacity Of Consumers Impact Your Business Model?
December 7, 2009
In February 2009, we published a c. notes article titled, Liquidity: 9 “What-Ifs” Worth Exploring. Even though liquidity is not a concern now for many credit unions, events outside of their control could quickly make it a serious issue. The article encourages credit unions to answer key valid questions to help prepare them for the possibility of heightened liquidity risk. The article can be found here.
This blog post is intended for a subset of credit unions that may come to the realization that a business model that assumes a high loan-to-asset ratio is inappropriate for them. The evolution of consumer spending and saving habits as a result of this economy may provide an opportunity for these credit unions to revisit their business model—focusing on if the credit union should tilt toward specifically serving borrowers, savers or both. Here’s some background to consider…
Over the past several years, many economists, most notably Stephen Roach of Morgan Stanley, warned of the consequences of the transformation of our economy from being income-based to asset-based. Said another way, starting in the late 1980s, the rapidly growing value of consumer assets played an increasingly larger role in the economy.
For example, during the second half of the 1990s, appreciation in stock market holdings emboldened consumers to spend due to the wealth effect. The bursting of the tech bubble reversed this wealth effect and initiated the last recession.
During the subsequent recovery, consumers began to feel wealthy from the value of their homes. We all know too well that consumers used their homes as ATM machines. This led to an increase in household debt from 90% of personal income to a record 133% by the end of 2007 as we went into our most recent recession. For more detail, see this article from the NY Times.
Many consumers have now reversed course. They are saving more than they are spending. In September and October, the personal savings rate was 4.6% and 4.4%, respectively (Source: U.S. Bureau of Economic Analysis). It wasn’t that long ago that consumers had a negative savings rate.
Layer onto this the fact that 14.4% of homeowners with mortgages are behind on their mortgage payments or are already in foreclosure (WSJ, More Homeowners Fall Behind on Mortgages, 11/21/2009) and 23% of all homes with mortgages are under water (WSJ, 1 in 4 Borrowers Under Water, 11/24/2009). And the icing on the cake: Over 70 million Baby Boomers are not feeling very wealthy as they head into retirement. They’ve likely already started to alter their spending habits.
To sum it up, for the foreseeable future there will likely be no bubble in asset appreciation to drive consumer spending and borrowing. Like they did for decades before the 1990s, many consumers will need to rely on their income to support their debt burden, not the value of their assets. In other words, they will likely be borrowing less.
What might this mean for credit unions? With about 18,000 depository institutions in the U.S., competition for loans may become quite interesting. Credit unions may find themselves facing irrational competitors who have once again loosened underwriting standards to achieve a potentially dangerous loan-to-asset ratio target. (Read more about appropriate measures of success in our white paper, Managing Success In A Changing World, to understand more about why this target could be dangerous.)
A subset of credit unions may want to take this point in history to revisit their business model and ask:
- Do we have a well-thought out plan to invest finite resources to continuously adapt to the competitive environment to remain a “credit” union, or would our membership be better served if we transitioned more toward a “savings” union?
- If we made that transition, what else would need to change in our credit union so as to serve our members and keep the credit union safe and sound?
There are successful credit unions that, for many years, have had a low loan-to-asset ratio. Many seem to have a clearly and narrowly defined target market. They remain successful even through this deep recession. Besides low loan losses, their low operating expenses contribute to their success. For example, they don’t need significant branch or lending infrastructure to support aggressive loan generation. Rather, they have an infrastructure that supports competitively priced deposit gathering and selective, organic loan generation. Branches that are needed can be low-cost storefronts, as an example. Investments, usually managed by one person, are very carefully invested so as to not take on undesirable interest rate risk. Granted, in this historically low rate environment, that means low investment yields. Many of these credit unions are satisfied with a resulting low ROA as they know they have positioned themselves for the benefits of higher rate environments when they return.
The transition to a “savings” union can take years and has many hurdles. It should not be taken lightly. While it will not be a reasonable alternative for most credit unions, it may be worth a strategic discussion for those that are seeing a critical change in the borrowing and saving patterns of their members. Those credit unions who seek a business model that is not as susceptible to credit risk could also benefit from this strategic discussion.