Economic & Credit Union Monthly Update

1. Economic & Credit UnionMonthly Update To access this monthly update go to: www.cunamutual.com/trendsreport Table of Contents Economy………………………….Page 2-9 Household Financial Condition…Page 10-15 Credit Union Loans….…..………Page 16-25 Credit Union Investments……….Page 26-29 Credit Union Savings……………Page 30-39 Credit Union Earnings……….….Page 40-51 Credit Unions and Members…...Page 52-55 Economic & CU Forecast……....Page 56-59 March 2016 If you have any questions or comments, please contact: Steven Rick, Chief Economist CUNA Mutual Group – Economics 800.356.2644, Ext. 665.5454 steve.rick@cunamutual.com

2. Economics Section • Gross Domestic Product • Labor Market • Inflation • Interest Rates • Auto and Home Sales • Exchange Rate and Oil Prices • Stock and Home Prices

3. Modest Economic Growth and Falling GDP Gap The economy expanded at a 1.4% annualized rate in the 4th quarter of 2015, below the long-run natural rate of 2.5%, due to slowdown in inventory accumulation, the plunge in energy sector capital spending and a big drag from net exports Consumer spending and housing investment were the main drivers of growth. Final Sales of Domestic Product added 1.62 percentage points and the change in inventoriessubtracted 0.22 percentage points.The economy grew 2.4% in 2015, the same as 2014. Expect the economy to grow 2.5% in 2016 and 2.75% in 2017. The economy is approaching its potential rate of output so the Fed will raise the fed funds interest rate 50 bps in 2016.

4. Strong Employment Gains Reach Full Employment The labor market added 242,000 jobs in February and 171,000 in January, above the 150,000 target. Average hourly earnings fell -0.1% in February but are up 2.2% during the last year as the labor market approaches full employment. The unemployment rate remained at 4.9% in February, which corresponds to 7.9 million unemployed workers. The labor force rose 555,000 (530,000 employed + 25,000 unemployed). The underemployment rate fell to 9.7% or 15.6 million (7.8 mil. unemployed, 6.0 mil. involuntarily part time, 1.8 mil. marginally attached). Continued employment gains will increase household incomes, wage growth, household formations, confidence and desire to borrow and spend. Expect loan growth to remain strong in 2016.

5. Inflation Below Target and Falling Inflation Expectations Nominal Interest Rates =Real Rates +Expected Inflation Nominal Rates Expected Inflation Real Interest Rates Headline inflation fell 0.2% in February but rose 1.0% during the last 12 months while core inflation rose 0.3% for the month and 2.3% during the last year. Core CPI inflation is approaching the Federal Reserve’s Core CPI target of 2.5%. The Fed’s preferred measure of inflation, the core PCE deflator is running at 1.3% year over year, below the Fed’s Core PCE target of 2.0%. There are 4 factors keeping inflation low: the negative output gap leads to idle capacity, a rising value of the dollar keeps import prices low, the “commodity super cycle” keeps commodity prices low, and low oil prices. The 10-year Treasury interest rate fell to 1.78% in February from 2.09% in January due to falling inflation expectations (11 basis points) and falling real interest rates (20 basis points).

6. Rising Interest Rates and Flattening Yield Curve The Federal Reserve did not raise interest rates at their March FOMC meeting but is expected to raise rates 0.50 percentage points in 2016. The Fed believes the new neutral fed funds rate is 3.25%. Interest rates will “normalize” in 2018at levels below previous plateaus due to lower real interest rates and lower expected inflation. The Fed will hold off ending its reinvestment program until 2017. By maintaining the current size of the Fed’s balance sheet and thereby depressing the term premium on long-term bonds, long-term interest rates will be slow to adjust upwards. This will cause a flattening of the yield curve over the next two years, which typically leads to downward pressure on credit union net interest margins.

7. Strong Auto Sales and Rising Home Sales U.S. vehicle sales slowed to a 17.5 million unit seasonally-adjusted annualized pace in February, from 17.6 million in January. Sales were up 6.7% year over year in February. Low gasoline prices are driving light truck sales. Consumer fundamentals (strong job growth, rising incomes and rising wealth) remain favorable to drive auto sales into the future. The trend pace of auto sales – inherent demand - that is consistent with the growth in the driving age population, income growth and household wealth is approximately 16.5 million units. Existing home sales fell 7.1 in February, falling to a 5.08 million annual rate, but are up 2.2% from February 2014. Home inventories remain tight (1.88 million) leading to home prices rising 4.4% year over year.

8. The Dollar and Oil Prices fell in February The U.S. dollar fell 2.2% in February from January due to market expectations that the Fed will raise interest rates at a slower pace in 2016 than previously anticipated. But over the last year, the dollar rose 4.4% which has reduced the cost of imports to U.S. residents but raised the cost of exports from the point of view of foreign buyers. This will worsen the trade deficit and slow economic growth. The price of a barrel of oil averaged $30.32 in February 2016, down from $50.60 one year ago, a 40% decline. This will slow energy investment but boost consumer spending.Oil Economics:  Poil= $10 =>PGas= $0.25 => growth 0.3% - 0.5% over next two years.

9. Volatile Stock Prices and Rising Home Prices Seasonally-Adjusted Purchase-Only Index Household balance sheets have improved over the last year due to rising home prices. Stock prices were 9% lower in February 2016 than one year earlier, creating a negative wealth effect. Home prices rose 5.4% over the last year, due to rising home demand colliding with a lack of housing inventory for sale .

10. Household Financial Condition • Income Statement • Balance Sheet

11. Household Income Statement Income + Change Debt = Taxes + Debt Interest +Spending+ Savings Personal income rose 0.2% in February and 4.0% year over year, due to rising rental and asset income. Wage income growth fell to -0.1%. Nominal spending rose 0.2% in February (led by durable good spending) and 3.8% year over year. The outlook for spending is positive because of the recent rise in discretionary items (recreational goods, furniture and appliances, and vehicles sales). Lower gas prices are freeing up cash for other purposes. Consumers had chose to save the gas windfall and/or pay down debt. Now they are starting to spend the gas windfall. Household balance sheets improved over the last year as home prices rose 6% and debt burdens fell. This will boost spending from the “wealth effect” and from additional access to credit. The lowest debt burdens & payments in 35 years is freeing up income for additional spending. A surge in household formations will lift spending in the next couple of years.

12. Household Income Statement Income +Change Debt= Taxes + Debt Interest + Spending + Savings Consumer credit rose $10.5 billion in January, an acceleration from $6.4 billion in December. Consumer credit rose 6.5% over the last year (revolving rose 3.9% and nonrevolving rose 7.9%). Big ticket items (auto and student loans) continue to be the major driver of consumer credit. Rising consumer confidence is a sign consumers are more willing to take on debt via credit cards. The household debt service ratio (mortgage and consumer debt payments (interest and principal) required to remain current on that debt as a percent of disposable personal income) rose to 10.07% in the fourth quarter from the record low of 10.01% in the fourth quarter of 2014 but below the record high of 13.22% in Q4 2007. Low debt payments freed up disposable income for additional consumption or savings.

13. Household Income Statement Income + Change Debt = Taxes + Debt Interest + Spending + Savings The saving rate (savings / disposable personal income) rose to 5.4% in February from 5.3% in January. Savings should decline as households begin spending some of their gasoline savings windfall. In this environment of modest savings, spending gains will be highly dependent on income growth and consumers preferences for additional savings. Consumer Confidence Index fell to 92.2 in February from 97.8 in January due to slow job and wage growth in January. Consumer Sentiment Indexfell to 91.7 in February from 92 in January due to falling stock prices. Improving GDP growth will boost consumer confidence and also the demand for credit.

14. Household Financial and Non-Financial Assets are Rising Financial assets as a percent of disposable income rose to $5.17 in the fourth quarter of 2015. This is a measure of the real annual purchasing power of financial assets (i.e., financial assets equal 5.17 years worth of disposable income). The ratio is up 22.5% from the cyclical low of 4.22 set back in the first quarter 2009. Rising stock prices were the major contributing factor. The real annual purchasing power of non-financial assets rose to $2.28 per dollar of disposable income (2.28 years worth of disposable income), up 16.3% since the cyclical low of 1.96 set in the third quarter of 2011, due mainly to rising home prices. Non-financial assets as a percent of disposable income is down 23% from the record high of 2.96 set back in the fourth quarter of 2005.

15. Household Balance Sheets Are Healing During the fourth quarter of 2015 , households’ debt burden ratio (debt-to-disposable-income) rose to 1.031, from 1.028 in the third quarter as debt grew faster than disposable income. The debt burden ratio is down 20% from the record high of 1.29 set in the fourth quarter of 2007. Financial institutions writing off and households paying off mortgage debt were the major contributing factors for the decline. The deleveraging phase of the business cycle has come to an end. If the growth rate in debt equals the growth rate of disposable income over the next few years the debt burden ratio will remain around the 100% which is what economists believe is sustainable in the long run. The real annual purchasing power of household net worth rose to $6.39 per dollar of disposable income (or 6.39 years worth of disposable income).

16. Credit Union Loans Section • Total Loans • Loan Quality • New Auto • Used Auto • Credit Card • Home Equity • Fixed-Rate First Mortgage • Adjustable-Rate First Mortgage

17. Rapid Credit Union Loan Growth Expect loan balances to grow 10% in 2016 and 9% in 2017 as the strengthening economy boosts members’ willingness and ability to accumulate debt and therefore satisfy some of their pent up demand that was accumulated during the weak and uncertain economic recovery of the last six years. But the loan growth disparity between small and large credit unions is rather large. In the last 12 months ending in Q4 2015, credit unions with assets greater than $1 billion reported an 12.4% increase in loan balances versus credit unions with assets less than $20 million reported loan growth of only 2.6%.

18. Improving Credit Quality As Unemployment Falls The credit union loan delinquency rate (loans two or more months delinquent as a percent of total loans outstanding) rose to 0.81% in January, from 0.79% in December 2015, but below the 0.83% reported one year earlier. Today’s delinquency rate is slightly above the 0.71% average reported for the years 2003-2007. So, 5 years after the Great Recession ended there appears to be few credit problems still lingering on credit union balance sheets from that time. Net charge-off rates rose to 0.54% in Q4 2015, from 0.46% in Q3 2015 and 0.53% in Q4 2014.

19. Rapid Credit Union Loan Growth Credit union loan balances grew at a 10.9% seasonally-adjusted annualized growth rate in January, similar to the pace set during the credit boom of 2003-2005. January’s seasonal factors usually subtract 0.45 percentage points to the underlying trend growth rate. The strong lending “season” will soon be upon us as April through August are the strongest loan growth months of the year.

20. Rapid New Auto Loan Growth Credit union new-auto loan balances grew at a 18.0% seasonally-adjusted annualized growth rate in January, a pick up in pace compared to the last few months. January’s seasonal factors usually subtracts 0.39 percentage points from the underlying trend growth rate. The economic factors that are currently supporting vehicle lending are an improving job market, greater access to credit, low interest rates, improving household balance sheets, and rising incomes. Expect car sales to increase 3% in 2016 to reach 17.8 million units sold as more pent up car demand is satisfied.

21. Rapid Used Auto Loan Growth Credit union used-auto loan balances grew at a 17.8% seasonally-adjusted annualized growth rate in January. January’s seasonal factors usually subtract 0.70 percentage points from the underlying trend growth rate. The used auto buying and lending season begins in March and runs through August.

22. Slowing Credit Card Growth Credit card loan balances grew at a 5.6% seasonally-adjusted annualized growth rate in January, due to rising consumer confidence and spending on durable goods. January’s seasonal factors usually subtract 238 percentage points from the underlying trend growth rate. The outlook for credit unions’ credit card lending is positive because of strong consumer fundamentals like the improving labor market, rising home and stock values, faster wage growth, and greater access to credit.

23. Rising Home Equity Loan Growth Credit union home equity loan balances grew at a 10.9% seasonally-adjusted annualized growth rate inJanuary, due to rising home prices and improving consumer confidence. January’s seasonal factors usually subtract 0.13 percentage points from the underlying trend growth rate. Home equity loan balances will remain strong due to rising home prices, the improving job market, rising consumer confidence, consumers releasing pent up demand for durable goods, and low interest rates.

24. Slowing Fixed-Rate First Mortgage Growth Credit union fixed-rate first mortgage loan balances grew at a modest 3.2% seasonally-adjusted annualized growth rate in January. January’s seasonal factors usually subtract 0.77 percentage points from the underlying trend growth rate. Credit union purchase mortgage originations should increase 15% in 2016 as housing demand recovers and refi activity increases slightly. A stronger labor market and rising wages will give more potential homebuyers the wherewithal to purchase a home. Moreover, fading memories of the housing bust will give homebuyers the confidence and willingness to purchase a home.

25. Strong Adjustable-Rate First-Mortgage Growth Credit union adjustable-rate first mortgage loan balances grew at a strong 22.6% seasonally-adjusted annualized growth rate in January. January’s seasonal factors usually add 0.13 percentage points to the underlying trend growth rate. Credit unions are placing more adjustable-rate mortgages on their books in preparation of the Federal Reserve raising short-term interest rates 50 basis point in 2016.

26. Credit Union Investments Section • Surplus Funds • Yield on Surplus Funds • Investment Maturities • Liquidity flows • Surplus Funds Distribution

27. Investments Are Falling and Yields Are Stable Surplus funds fell to 30.3% of assets in January, below the 32.8% in January 2015. Investments as a percent of assets fell over the last 2 years as loans growth accelerated. Loans now make up 65.6% of assets, up from the cyclical low point of 57% set in March 2013. The yield on surplus funds fell to 1.19% in Q4 2015, down from 1.21% in Q4 2013. Loan yields fell to 4.66% in Q4 2015, the lowest in credit union history, from 4.75% in Q4 2014. With loan balances expected to grow another 10% in 2016 ($76.4 billion), expect surplus funds as a percent of assets to fall below 28% by year end, the lowest level of liquidity since February 2009.

28. Falling Investment Maturities as Yield Curve Flattens Surplus funds with a maturity less than 1 year rose to 46.6% in January 2016, up from 44.8% in January 2015. The yield curve flattened in January (as measured by the difference between the 3-year Treasury interest rate and the fed funds interest rate) to 80 basis points due to the Fed raising short-term interest rates in December and capital inflows from the rest of world. Longer term investments as a percent of surplus funds fell significantly over the last year; 5-10 year investments fell to 7.5% of surplus funds from 7.7% a year earlier while 3-5 year investments fell from 20.9% to 19.4%.

29. Credit Unions take Advantage of Arbitrage Opportunity From 1 month ago From 1 year ago Credit union borrowings grew $10.4 billion in January, in part to take advantage of a recent riskless arbitrage profit opportunity. In December 2015, the Federal Reserve increased the interest rate paid on excess reserves to 0.50%. This created an arbitrage opportunity whereby financial institutions can borrow funds in the short term interbank credit markets at a lower interest rate, say 0.35%, and deposit the funds into their regional Federal Reserve Bank account earning 0.50%. The principal limiting factor on the amount of credit union borrowings is their quarter-end capital-to-asset ratios. The arbitrage opportunity exists because the government sponsored enterprises, Fannie Mae and Freddie Mac, cannot deposit their excess liquidity at the Fed and must therefore sell their excess liquidity in the fed funds market.

30. Credit Union Savings Section • Total Savings • Savings Distribution • Savings Interest Rates • Regular Share • Share Draft • Money Market Account • Share Certificate • Borrowings

31. Slower Saving Growth in 2016 Savings balances rose 6.9% in 2015 due to savings at the gas pump, rising household income, strong job growth, and fast membership growth. Savings balances are expected to grow 5% in 2016 and only 4% in 2017 as members use more savings for purchases and higher interest rates lead rate-sensitive members to transfer funds to money market mutual funds.Savings growth disparity is rather large. In the last 12 months ending in Q4 2015, credit unions with assets greater than $1 billion reported a 8.6% increase in savings balances versus credit unions with assets less than $20 million reported savings growth of only 2.0%.

32. Short-term Liquid Funds Dominate Savings Mix Regular shares made up 34.7% of total savings in Q4 2015 as members prefer short-term liquid deposits. This is the highest percentage since 2005. Members anticipate the Federal Reserve will raise interest rates soon, and therefore do not want to lock up their funds in term deposits. Credit union CD interest rates are slowly rising as liquidity tightens at many credit unions reporting strong loan growth. With the Federal Reserve expected to raise the fed funds slowly during 2016, expect credit union CD and money-market account interest rates to rise throughout 2016.

33. Surging Saving Growth as Gas Prices Fall Credit union savings balances grew at a 6.0% seasonally-adjusted annualized growth rate in January, due mainly to low gas prices putting more money in members’ pockets. January’s seasonal factors typically subtract 0.13 percentage points from the underlying savings trend growth.

34. Rapid Regular Share Growth Credit union regular share balances grew at a 10.5% seasonally-adjusted annualized growth rate in January, due mainly to low gas prices putting more money in members’ pockets. January’s seasonal factorstypically subtract 0.04 percentage points from the underlying regular shares trend growth.

35. Rapid Share Draft Growth Credit union share draft balances grew at a 9.5% seasonally-adjusted annualized growth ratein January. Seasonal factorstypically subtract 1.44 percentage points from the underlying share draft balance trend growth.

36. Rising Money-Market Account Growth Credit union money-market account balances grew at a 7.1% seasonally-adjusted annualized growth rate in January, due mainly to low gas prices putting more money in members’ pockets. January’s seasonal factors typically subtract 0.05 percentage points from the underlying money-market account balance trend growth.

37. Resurgent Share Certificate Growth Credit union share certificate balances rose a 4.1% seasonally-adjusted annualized growth rate in January. January’s seasonal factorstypically add 0.48 percentage points to the underlying share certificate trend growth. Members will begin shifting funds from regular shares to CDs and money-market mutual funds when short-term interest rates rise later this year.

38. Falling IRA Growth Credit union IRA balances fell at a 11.1% seasonally-adjusted annualized growth rate in January. January’s seasonal factorstypically subtract 0.69 percentage points from the underlying IRA balance trend growth.

39. Resurgent Borrowings Credit union wholesale borrowings rose at a 27.6% seasonally-adjusted annualized growth rate in January. January’s seasonal factorstypically add 2.29 percentage points to the underlying borrowings trend growth. Credit union borrowings grew $10.4 billion in January, in part to take advantage of a recent riskless arbitrage profit opportunity. In December 2015, the Federal Reserve increased the interest rate paid on excess reserves to 0.50%. This created an arbitrage opportunity whereby financial institutions can borrow funds in the short term interbank credit markets at a lower interest rate, say 0.35%, and deposit the funds into their regional Federal Reserve Bank account earning 0.50%.

40. Credit Union Earnings Section • Return on Equity • Yield on Assets • Cost of Funds • Net Interest Margin • Operating Expenses • Fee Income • Other Income • Provision for Loan Loss • Net Income • Capital Ratio • Asset Growth

41. Falling Return on Equity Credit union return-on-equity ratios fell to 6.5% in 2015 from 9% in 2014. A higher ROE ratio allows for faster asset growth, which then leads to lower operating expense ratios, higher profit margins, and ultimately greater earnings. The disparity between large and small credit unions’ return-on-equity ratios remained large in 2015. Credit unions with assets exceeding $1 billion reported ROE ratios of 8.4%, more than twice that reported by credit unions with assets less than $100 million.

42. Rising Yield on Assets Credit union loan growth of 10-11% in 2015-16 will shift assets away from low yielding investments and into higher yielding auto and mortgage loans. This will push credit union assets yields above the record low of 3.36% set in 2014. Faster economic growth in 2016 will put upward pressure on interest rates with the 10-year Treasury crossing over 2.5%. This will push mortgage rates up and boost earnings. The Fed will raise the fed funds interest rate slowly in 20165 raising the yields on short-term credit union investments. Aggressive loan pricing by banks returning to the consumer lending arena will, however, lower net returns on some loans

43. Rising Cost of Funds Rising short-term interest rates in 2016 will increase credit union cost of funds from the record low mark of 0.52% set in 2015. The rise will be modest as excess liquidity will allow deposit interest rates to lag increases in market interest rates. With almost all member certificate of deposits repriced to today’s low interest rates, the funding cost increase will come sooner than it did during the last rising interest rate cycle of 2004. Rising interest rates will encourage members to shift funds out of core deposits and into higher yielding money-market accounts, a liability mix effect.

44. Stable Net Interest Margins Net interest margins will decrease in 2016 cost of funds rise faster than asset yields. Credit union net interest margins reached the lowest in history in 2013 due to historically low interest rates and excess liquidity. Deregulation over the last 30 years has increased competition in the financial services arena, resulting in lower net interest margins. For an individual CU, margins will also be determined by local market demographics: population growth, median household income, local industry, age trends. Margin compression is forcing CUs to increase the array of financial products and services offered while at the same time boosting efficiency and productivity.

45. Falling Operating Expense Ratios Operating expense ratios will decline slightly over the next 2 years as the growth rate in assets exceed that of operating expenses. Corporate stabilization assessments are expected to be zero in 2016 because the combination of corporate capital written off ($5.6 billion) and total assessments paid to date ($4.8 billion) is close to what the losses are likely to be. NCUSIF premiums are expected to be zero in 2016 due to a build up of reserves for insurance losses and less CU failures. However, credit unions will experience rising compliance costs for new Dodd-Frank Act regulations and new Consumer Financial Protection Bureau rules.

46. Falling Fee Income Ratios Fee income as a percent of average assets will continue its 7 year decline as the economic recovery lowers penalty fees. Moreover, web and mobile banking is providing members easier access to account balance information which reduces penalty fees. Fees from checking accounts serves as the single largest source of credit unions’ fee income. The average percentage of fee income derived from nonsufficient funds (NSF), overdraft, and courtesy pay fell to 34% in 2013.The CFPB’s expected focus on checking/ODP in 2015 puts a big income stream at risk, and continuing issues with overdraft revenue could prove challenging.

47. Stable “Other Income” Ratios The end of the mortgage refinance boom will reduce loan origination fees and “gains on sale” of mortgages over the next 2 years. Interchange income may decline in 2016 if interchange rates fall more than the increase in card transactions. Merchants have incentives to move customers to new alternate low-cost payment systems, reducing the market power of the card networks. The interchange fee cap rule (October 1, 2011) capped the maximum fee charged per debit card transaction to 21 cents (plus an additional 2-3 cents for fraud prevention) for institutions greater than $10 billion.

48. Rising Provisions for Loan Loss Ratios Provision for loan loss ratios will increase slightly in 2016 due to strong loan growth. But falling loan net charge-offs, tight underwriting standards, an improving labor market, rising home prices and a still overfunded allowance for loan loss account will keep loan loss provisions below long term levels. Many credit unions still have over-funded allowance for loan losses. leading to provisions lower than net chargeoffs over the last few years. Home prices are expected increase 4% in 2016, reducing the number of mortgages at risk of foreclosure.

49. Falling Return-on-Asset Ratios Corporate Stabilization Expense (basis points of average assets) 2009 = 3 bps 2010 = 11 bps 2011 = 18 bps 2012 = 7 bps 2013 = 6 bps Credit union return-on-asset ratio will decline to 0.70% in 2016. Rising asset yields – due to faster loan growth and modestly higher market interest rates - will not outpace higher funding costs. This will reduce net interest margins. Expect loan loss provision expense to rise and operating expense ratios to rise. The disparity between large and small credit unions return-on-asset ratios remained large in Q4 2015. Credit unions with assets exceeding $1 billion reported ROA ratios of 0.89%, more than twice that reported by credit unions with assets less than $100 million.

50. Rising Capital Ratios Credit union capital-to-asset ratios will continue to rise in 2016 as capital accumulation outpaces asset growth. Credit unions continue to build their buffers above the 7% target considered to be “well capitalized” under NCUA’s Prompt Corrective Action rule. By the end of 2017, capital ratios will approached 11.2%, approaching the record high set back in 2006.