November 5, 2021

Deposit Explosion Puts Pressure on Credit Union Capital

To the outsider, the influx of deposits credit unions have experienced since the pandemic put many aspects of life on hold would seem to be a good situation. But the corresponding declining market for consumer loans has put credit unions in a capital crunch.

With the uncertainty about how long credit unions will hold those deposits and a lack of short-term lending opportunities, credit unions have largely turned to invest their excess cash in short-term federal funds with such low returns that it threatens their net worth ratio.

Credit union leaders search for a balance that allows them to weather this current period without having to sell off assets while determining how much of this change in savings habits is the new normal or if the savings/consumer loan ratios will eventually return to pre-pandemic levels.

Deposit Trend for Credit Unions

A deposit boom has inundated credit unions since the lockdowns began a year and a half ago, with consumers holding off on big-ticket purchases because of economic uncertainty and socking away the three rounds of stimulus funds.

According to NCUA, insured shares and deposits stood at $1.51 trillion through the second quarter of 2021, a 14.8 percent jump over the previous year. Total shares and deposits jumped 15.0 percent year over year to $1.71 trillion.

The growth rate has slowed slightly from the 20-plus percentage points during 2020 and the first quarter of 2021 but still remains significantly higher than pre-pandemic growth rates.

One question facing credit union leaders now is this: what will those growth rates look like in the coming quarters now that stimulus and extra unemployment benefits have stopped. Will inflation cause depositors to begin withdrawing some of those funds? How liquid do they need to be with those funds to make loans or satisfy payout demands in the coming months?

Low-Yield Investing Predicament

In normal times, credit unions would roll additional deposits into short-term consumer loans, such as for automobiles, home improvements, and other personal loans. But that market has dried up somewhat as consumers were stuck at home and put off big-ticket purchases.

The second quarter did show a small uptick in short-term loan demand, particularly for autos, but it still wasn't enough to absorb the influx of deposits. Credit Union Times reported auto loan balances were up 2.1 percent in the second quarter. CUT noted the quarterly change in net liquidity (change in share balances versus change in loan balances) was negative in the second quarter, the first time since September 2019.

Tim Scholten, president of the credit union and community bank consultancy Visible Progress, told American Banker that credit unions were issuing certificates of deposit that payout about 2 percent interest, only about half what credit unions would make on loans. Many credit unions are parking cash in overnight fed funds that pay a mere quarter of a percent, making the spread between interest paid and interest earned negative. Scholten noted one of his bank clients had at least 10 percent of its total assets parked in such low-yield fed funds.

This lack of income puts the squeeze on credit unions' net worth ratio, which by regulation must be kept at 7 percent or better. A credit union that sees its net worth ratio dip into the 6 percent range risks having to sell assets to remain viable. NCUA reported the industry's aggregate net worth ratio dipped to 10.17 percent in the second quarter, down from 10.46 percent a year earlier.

While the aggregate number looks relatively strong, smaller credit unions, in particular, could struggle with their net worth ratios. American Banker, for instance, reported that North Country Federal Credit Union in South Burlington, Vermont, has seen its net worth ratio tumble from more than 10 percent in December 2019 to 8.6 percent at the end of the second quarter. North Country anticipates another 12 percent to 13 percent growth in deposits in the third quarter, pushing the risk that its ratio could fall even more. "The reality is neither earnings nor loan growth has matched the pace of deposit growth," North Country CEO Bob Morgan told American Banker.

Long-Term Investing Predicament

One solution for credit unions would be to invest more capital into long-term loans, such as home mortgages, but that puts them at risk if the consumer saving trend turns into a bubble. The CUT report noted first mortgage holdings increased by 2.7 percent in the second quarter.

Credit unions have fewer options than banks when it comes to accessing capital if they do have to return those funds to consumers. If a credit union turns to borrow to pay back consumers, they further erode their net worth ratio.

The other downside to long-term loans such as mortgages is that they also return lower interest rates than shorter-term consumer loans. If a credit union has too much funding tied up in long-term loans, it might not be able to service members seeking short-term loans as the economy improves — another issue that could have a greater effect on smaller credit unions.

American Banker reported that Truliant Federal Credit Union in Winston-Salem, North Carolina, at about four times the size of North Country, was able to roll more money into business loans and mortgage loans to maintain a strong net worth ratio despite growing deposits.

A Solution for High-Yield, Short-Term Loans

Another solution for credit unions is to regain those more profitable short-term loans that have been their bread and butter over the years.

While that market may grow back organically through their local branches, Garnet Capital Advisors provides immediate opportunities for credit unions to partner with loan originators to book high-quality, short-term loans. These loan packages will provide a greater net return than the capital invested in federal funds or CDs, allowing credit unions to maintain a strong net worth

Garnet Capital works to tailor packages to your credit union. You purchase the kinds of loans you are comfortable owning, so you don't put your staff into unfamiliar situations.

Contact our expert advisors today to learn how we can put together a loan package that gets you back into the business you desire.