Euro Crisis: Implications for U.S. Credit Unions

The euro crisis may seem remote to many U.S. credit union leaders, but the risks are very real and continue to grow. This post will provide a quick overview of the crisis and the potential risks to U.S. credit unions.

Euro Crisis Overview

The euro crisis has dragged on since late 2009 when Greece admitted that its government debt had reached an all time high of 300B euros. Greece has already received two bailouts (May 2010 and March 2012) from the European Union and the IMF and will need to make a bond payment amounting to 3.2B euros on August 20. Ireland and Portugal also received bailout packages in November 2010 and May 2011 respectively.

Financial markets have demanded a growing risk premium on the government debt of highly levered Euro countries like Spain and Italy as evidenced by growing spreads between Spanish and Italian bond yields vs. those of core Eurozone countries, such as Germany and France.  Spain, in particular, has found it very difficult to service its government debt and is on the verge of asking for a bailout.  The EU agreed to a separate deal to bail out Spanish banks earlier this year.

                    Long-Term Bond Yields of Key Eurozone Countries

           Note: Chart displays yields for government bonds with maturities of 9 or 10 years.

           Source: OECD

Another notable feature of the euro crisis is the hard line shown by Germany and other AAA-rated European countries to the financially troubled Eurozone countries. Germany and other like-minded countries have made austerity (cuts in government spending / tax increases) a condition for receiving bailout funds.   Additionally, Germany has refused to consider joint issuance of eurobonds, i.e., any mutualization of government debt, or to serve as the Eurozone’s lender of last resort. 

Implications for U.S. Credit Unions

The euro crisis has been a major contributing factor behind a global flight to safe assets.  This flight to safety is having multiple side effects:

• Interest rates in perceived safe haven countries have been steadily dropping since early 2011.  With both the financial markets and the Fed putting downward pressure on interest rates, credit unions’ net interest margins and investment income are both lower in Q1 2012 compared to Q1 2011.

                        Long-Term Bond Yields of Perceived Safe-Haven Countries

       Note: Chart displays yields for government bonds with maturities of 9 or 10 years.

       Source: OECD

• The U.S. dollar has steadily gained in value against the euro since early 2011 making it more difficult for U.S. companies to market their products overseas.  A decline in U.S. exports would likely harm U.S. economic growth; thus, impacting credit unions indirectly.

The euro crisis has also placed the overall stability of the U.S. financial system at risk.  While U.S. banks have reduced their holdings of Eurozone debt, substantial indirect exposures remain. Per the IMF:

“U.S. banks have only a limited direct exposure to countries in the euro area periphery—that is, if we only look at their loans to these economies. This exposure is somewhat greater if we also consider their indirect relationship to banks and firms in these countries, through guarantees and credit derivatives.

U.S. banks have more substantial interconnections with the large banks from the core euro area countries and the United Kingdom. They could therefore be affected both by problems in core euro area banks, whether caused by a deteriorating situation in their countries or by the spillovers of problems in the euro area periphery to which such banks are exposed. 

The crisis has elevated the overall reputation risk of the entire financial system. Should a large European bank fail, Americans’ trust in the financial stability of their own financial institutions, including credit unions, could suffer, as it did after the failure of Lehman Brothers.

 Finally, European banks are retrenching in the U.S.  According to the Financial Times, “bank failures, asset write-downs and the sale of loans and businesses have sent U.S. assets of Eurozone banks tumbling by $540bn from their $1.51tn peak in September 2007.”  Large U.S. banks have been the primary beneficiary of this trend with Wells Fargo, JPMorgan Chase and Capital One purchasing significant assets of European banks.  While this retreat translates into less competition for large U.S. banks, the net impact for credit unions is less clear.

If you would like to monitor the latest euro crisis developments, the Sustainable Growth Blog team suggests the following resources:

• Bloomberg – Euro Crisis page
• Wall Street Journal – Europe’s Debt Crisis page*
• Financial Times – Euro in Crisis page*

* Subscription required

A Trillion and Counting

With the credit union system recently passing a trillion dollars in assets, we started to wonder what drove the growth over the last decade. Was it through improvements in share of market, i.e., credit unions acquiring a higher percentage of the total consumers in financial services? Perhaps it was share of wallet, i.e., credit unions capturing a larger slice of members’ deposits and loans? Or could there be something else?

To get a proxy for share of market, we looked at the total number of credit union members over the total U.S. population. As you can see from the chart below credit unions have been increasing their market share and now represent just under 30% of the U.S. population. While there is some double-counting (a consumer could belong to more than one credit union), the evidence strongly suggests that credit unions have successfully grown share of market over the past 10 years.

To develop a proxy for consumers’ share of wallet, we used the Federal Reserve’s Flow of Funds Report which contains rich data on consumers’ (and financial institutions’) balance sheets. The next chart looks at credit union balances of home mortgages, consumer credit and total currency and deposits as a percentage of the same data points for total households and non-profits. Not surprisingly, credit unions have been increasing their share of wallet over the past decade in home mortgages and losing share on consumer credit, as they allocated more of their balance sheet to real-estate loans.  Indirect lending and captive finance companies led to a decline in the share of consumer loans. Total deposits have recently shown relatively strong gains during the height of economic recession as consumers looked for safe institutions with more attractive yields.

Putting the two together, it appears the industry has been heavily focused on gaining share of market over share of wallet. Building branches, consolidating and expanding fields of memberships have all helped expand membership to nearly a third of the U.S. population. However, share of wallet results have been mixed with total deposits showing strong recent gains. Could the key to growth for the next decade require a shift in strategy from acquiring new members to more of a focus on deepening relationships with existing members?