It is no surprise to many credit unions leaders to say that 2023’s operating environment has been uncertain. The year has presented its share of challenges. Key performance indicators, such as operating surplus, have hit historic lows in some regions, but there’s potential for improvement on the horizon. Ahead of our Momentum 2023 Summit, Bryan Yu, Chief Economist, Central 1, discussed the pressing economic challenges facing credit unions today.
The drivers of deteriorating performance are well known. As financial intermediaries, credit unions link savers/depositors with households and businesses seeking funds, largely generating income from difference on rates paid on shorter term deposits against loans of longer duration at higher rates to account for risk. However, this has moved against credit unions in the latter part of the pandemic amidst the significant inflationary backdrop with the Bank of Canada, like its peers, abandoned the view that inflation would be transitory. Short-term policy rates around the globe took flight in a bid to quell the risks of entrenched inflation. In Canada this has meant a 20 year high in the policy rates. At the same time, longer term rates have at least until recently been anchored by steady future inflation expectations, and fears of weakening economic activity.
In this challenging landscape, credit unions have faced a perfect storm. Short-term deposits have quickly adjusted to provide savers with better, low-risk returns, while those with fixed-rate mortgages and non-revolving loans have been reluctant to refinance to maintain their relatively lower rates. This, coupled with the rapid increase in home prices and higher interest rates, has created a sense of unease among prospective buyers, impacting mortgage and broader loan growth. Additionally, credit unions are not immune to the broader inflationary drivers in play driving up cost of operations, including rising wage pressures.
Is a turnabout in sight? Not immediately, but it’s possible. While short-term rates have likely reached or are approaching peak, a return to a more normal yield curve is likely a year or more away. Achieving this requires a clear path to normalized inflation, which is still uncertain, and there’s a chance that the economy may need to face further challenges and further deterioration before reaching that point.
For credit unions, there’s a need to adjust. They’re expected to reprice loans higher over the next two years, but they will also face some competition to hold onto this business, considering households’ sensitivity to interest rates. This means some improvements to interest margin, but renewal rates could very well remain below deposit rates. Additionally, there are risks around household financial health, as rate repricing may lead to more members falling behind on their payments, potentially resulting in more delinquent loans and higher credit losses.
This Tuesday, Finance Minister Chrystia Freeland announced that the federal government is pushing banks to comply with new guidelines intended to help financially stressed mortgage borrowers. This move further underscores the current challenging environment and is also the most recent addition to a series of federal measures aimed at the banking sector.