By Ray Birch
MADISON, Wis.—Credit unions are bracing for a doubling and possibly a tripling of loan losses next year, and they're not waiting for delinquencies to climb to set the money aside.
“What will happen is somewhat unpredictable,” said Steve Rick, chief economist with CUNA Mutual Group. “I'm seeing credit unions really pick up their provisions for loan losses. They're not waiting for the elevated delinquencies and charge-offs to hit. They're putting as much into provisions as they can afford, which will drive down their earnings in the second and third quarters. They expect their charge-offs to double, if not triple next year.”
Rick’s insights are part of a week-long series in CUToday.info exploring different scenarios for which credit union leaders must be prepared in the second half of the year.
“I think a tripling of losses would be by far be the worst-case scenario,” he said. “A lot more credit unions are saying they expect to easily double their charge-offs next year, compared to 2019 levels. They are basically making provisions with that in mind.”
Those levels of reserves should be strong enough to cover losses that are certainly coming after the forbearances expire, said Rick, who looked back to the Great Recession for a comparison.
“Credit unions are possibly using what happened in 2008 and 2009, with the Great Recession, as a guide,” Rick said. “Then they saw charge-offs more than double.”
Not Like the Great Recession
Rick emphasized a point made by a number of experts: the fundamental problem in the mortgage market during the Great Recession led to massive home loan defaults, the largest asset held by most consumers, which is not the issue today. He does not expect the signficant mortgage defaults seen 10 years ago to occur within the next year, which will lead to a lower level of losses this time.
“We don’t expect all those mortgages to go bad this time, and we don't expect home prices to collapse,” said Rick. “So, it's mainly going to be consumer loans like credit cards, auto loans and student loans that are going to get hit. Hopefully mortgages will largely be spared.”
If mortgage losses increase to levels beyond what many experts are now forecasting, it will be because the pandemic lasts well into 2021, according to Rick.
“If this continues for an extended period I don’t know what to say,” he said. “I saw Google is not going to let people back into the office until next June. So, they expect another full year of this, and there are some pretty smart people working there.”
Looking back again to the Great Recession, loan losses at credit unions tripled during those years, said Rick.
“Charge-offs went from .4% to 1.2%., so a multiple of three,” said Rick, who believes a doubling of loan losses is the scenario more likely to play out over the next year.
A Tough Q4
When might credit union balance sheets starting feeling those blows?
“It’s time for credit unions to prepare now—don't wait for the delinquencies to begin to rise,” said Rick. “The fourth quarter is when all these loan payment deferrals will start ending, and I know some credit unions are doing a second round of three-month deferrals for members who are asking for that. But by the fourth quarter credit unions will say ‘no more.’ That’s when it will start to get really bad in terms of charge-offs.”
To further prepare for the losses, many CEOs are turning their attention to even tighter expense management.
“They're instituting a hiring freeze, they’re freezing their marketing budgets, and all discretionary spending is being put on hold,” said Rick. “You won’t see a lot with expansion—new branches or administration buildings—until all this shakes out. Non-essential expenses are being put on hold.”
Credit unions are also ramping up their collections departments, which Rick agrees is a prudent move.
Steve Rick
“It’s important to hire those people now and train those people so they know how to be a good collection agent when the losses come,” said Rick. “You don’t want to wait until the trouble hits to hire new collectors.”
The Bigger Picture
As for the overall economy, Rick believes GDP will make a small comeback this quarter.
“That just started in July, and we could see 10% to 15% growth in GDP in the third quarter,” said Rick, who cautioned that if new, widespread stay-at-home orders are issued by states, that could have an impact on the forecast.
“But I still believe we could see 15% GDP growth, which would essentially mean the recession is over,” stated Rick. “But the thing is, we're still in the ditch. We're still a huge hole. If people think, great, the recession is over, well, the problems are not over. We just fell off a cliff and we are just now starting to climb back out of a very deep hole. To get back to where we were before the pandemic, in terms of GDP, will take two or three years.”
More in this series: