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Brian Turner Director, Chief Strategist

S TRATEGIC O UTLOOK ON THE E CONOMY, I NTEREST R ATES AND M EMBER B EHAVIOR AND THE I MPACT ON C REDIT U NION. Brian Turner Director, Chief Strategist. E CONOMIC G ROWTH. RECOVERY IS “SLOW AND PAINFUL” IMPEDIMENTS TO GROWTH- 1) WEAK CONSUMER SPENDING …..Job Insecurity

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Brian Turner Director, Chief Strategist

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  1. STRATEGIC OUTLOOK ON THE ECONOMY, INTEREST RATES AND MEMBER BEHAVIOR AND THE IMPACT ON CREDIT UNION Brian Turner Director, Chief Strategist

  2. ECONOMIC GROWTH • RECOVERY IS • “SLOW AND PAINFUL” • IMPEDIMENTS TO GROWTH- • 1) WEAK CONSUMER SPENDING • …..Job Insecurity • …..Home Values & Net Wealth • MARKET UNCERTAINTY • …..Instability & Volatility • …..Uncertain Regulatory/Legislation +3.2% -4.1% +2.5% +12.3%

  3. ECONOMIC GROWTH • RECOVERY IS • “SLOW AND PAINFUL” • IMPEDIMENTS TO GROWTH- • 1) WEAK CONSUMER SPENDING • …..Job Insecurity • …..Home Values & Net Wealth • MARKET UNCERTAINTY • …..Instability & Volatility • …..Uncertain Regulatory/Legislation GROWTH PROJECTION (Real GDP – QoQ) ONE-YEAR MOVING AVERAGE FORECAST Source: US Dept of Commerce

  4. ECONOMIC GROWTH • RECOVERY IS • “SLOW AND PAINFUL” • IMPEDIMENTS TO GROWTH- • 1) WEAK CONSUMER SPENDING • …..Job Insecurity • …..Home Values & Net Wealth • MARKET UNCERTAINTY • …..Instability & Volatility • …..Uncertain Regulatory/Legislation 2003 2007 2009 2013 Unemployment Rate GDP Source: US Dept of Labor, Commerce FROM FROM 2003 – 2007 2009 – Present Unemployment Rate6.3% to 4.4% 9.9% to 7.3% Average GDP +3.1% +2.3% Avg Consumer Spending +3.3% +2.2%

  5. ECONOMIC GROWTH • WHY UNEMPLOYMENT REMAINS WEAK Since 2009 Since 2012 (Mil) Pct (Mil) Pct Population +10.2 +4.3% +2.4 +0.9% Labor Force +1.3 +0.9% +0.8 +0.5% Labor Force/Population 65.3% 63.2% Employed +4.3 +1.0% +2.0 +1.4% Unemployed -2.9 -20.6% -1.2 -9.3% Employment/Population 59.3% 58.6% Not in Labor Force +8.8 +10.8% +1.6 +1.7% Not in Labor Force/Population 34.0% 36.8% EMPLOYMENT WEAK Source: US Dept of Labor

  6. ECONOMIC GROWTH FOMC HAS SET “RISING RATE” TARGETS UNEMPLOYMENT RATE- ……….BELOW 6.5 PERCENT CURRENT INFLATION- ……….BELOW 2.5 PERCENT INFLATION OUTLOOK- ……….BELOW 2.5 PERCENT TARGET UNEMPLOYMENT RATE INFLATION – CURRENT INFLATION – OUTLOOK Source: US Dept of Labor

  7. IMPACT ON MEMBERS HOUSEHOLD NET WEALTH CHANGE IN HOUSEHOLD NET WORTH (Billions of Dollars) EMPLOYMENT WEAK CONSUMER SPENDING BEHAVIOR Job Security Net Wealth NO CHANGE IMPROVING Source: Board of Governors of the Federal Reserve System

  8. IMPACT ON MEMBERS HOME VALUES TRENDING UP 30% below 2006 Back to 2003 levels CHANGE IN AVERAGE HOME VALUES (Year-over-Year thru July 2013) U.S. +12.4% +12.5% +12.2% +9.5% +6.3% +16.9% +24.8% +3.5% +7.8% +9.7% +27.5% +7.6% +20.8% +18.9% +18.5% +20.4% +8.5% +13.7% Source: S&P Dow Jones Indices

  9. IMPACT ON MEMBERS MEMBERS’ SELECTION Only One Income Range Select Credit Unions Greater the Income, the Less Selection of Credit Unions MEMBERS’ CHOICE OF PRIMARY FINANCIAL INSTITUTION (By Average Household Income) Source: CUNA National Member Survey CREDIT UNIONS BANKS

  10. IMPACT ON MEMBERS MEMBERS’ SELECTION Industry Has Done Well to Balance Demographics Work Still to Do to Attract Younger Members AGE DISTRIBUTION OF CREDIT UNION MEMBERS Source: CUNA National Member Survey

  11. IMPACT ON MEMBERS • COMPARING • GENERATIONS • Targeting Millennials • Twice likely to name a family member as someone they admire • 2) Consider “getting rich” an important goal • More likely to trust institution than previous generations at same age COMPARING GENERATIONS (at 18 to 23 YEARS OLD) 40.6 million 41.9 million 24.6 million Source: Pew Research Center

  12. IMPACT ON MEMBERS TRUSTED SOURCES FOR INFORMATION 1) Women carry 76-million credit cards…. 8-million more than men 2) Women own 40% of all US companies 3) Women control 51% of private wealth in US 4) US women have more spending power than Germany, France and UK, combined MOST TRUSTED SOURCE OF INFORMATION - WOMEN • Gen X Gen Y • (1965-75) (1976-2001) • 1. Friend and Family 55% 59% • Company Web sites 57 58 • Online Reviews 32 38 • 4. Product Packages 22 19 • 5. Television 14 13 • 6. Magazine or Newspapers 17 12 • 7. Store Personnel 12 9 • 8. In-store Materials 11 8 • 9. Magazine or TV Ads 6 5 • 10. Online Ads 3 3 Source: Radar Research

  13. STRATEGIC OUTLOOK ON MEMBER BEHAVIOR • SPENDING OUTLOOK ENTIRELY DEPENDENT ON EMPLOYMENT • Improvement in Household Wealth Helping to Improve Sentiment. • Job Insecurity Putting Damper on Desire to Spend. • But Growing “Fatigue and Obsolescence“ Sparks MARKET FRENZY • GROWTH OUTLOOK REFLECTS MODERATE EXPECTATION FOR LOANS FOR NEXT YEAR • GDP Projected to grow about 2.8 percent in 2014 (Moderate) • Portends Moderate Growth in Consumer Spending (two-thirds of GDP) • Suggests Moderate Growth in Consumer Loans in 2014 • EXPECTATION REFLECTS ANOTHER STRONG OUTLOOK FOR SHARE GROWTH • Share Growth Follows Household Disposable Income • Disposable Income Expected to Increase Again in 2014 • Suggests Share Growth in 2014 will Outpace 2013

  14. IMPACT ON INTEREST RATES INTEREST RATES SHAPE OF THE YIELD CURVE IMPACT OF ASSET AND FUNDING SPREADS ALLOCATION OF BALANCE SHEET Dec2010 October 2013 Dec2011 Source: Bloomberg

  15. IMPACT ON INTEREST RATES CREDIT UNION LOAN PRICING AND RELATIVE SPREADS Dec Oct YTD Nominal Net 2012 2013 Change Change Spread AVG CU LOAN RATES- 48Mo Vehicle 3.06% 2.73% - 0.33% +0.15% - 0.48% 60Mo Vehicle 3.16 2.82 - 0.34 +0.43 - 0.77 15yr FRM 2.97 3.66 +0.69 +1.07 - 0.38 30Yr FRM 3.53 4.61 +1.08 +1.03 +0.05 AVG SHARE RATES- Share Drafts 0.12% 0.11% - 0.01% - 0.02% - 0.01% Regular Savings 0.19 0.14 - 0.05 - 0.02 +0.03 MMkt Shares 0.23 0.19 - 0.04 - 0.02 +0.02 1yr CD 0.70 0.41 - 0.29 - 0.02 +0.27 AVERAGE MARGINAL SPREADS2.93% 3.38% -0.21% +0.69% - 0.40% Source: Bloomberg, Datatrac DECREASE IN PRICING SPREAD ADVERSE IMPACT ON EARNINGS

  16. STRATEGIC OUTLOOK ON INTEREST RATES • DEPENDS ON FEDERAL RESERVE’S COMMITTED TO STATED TARGETS • Unemployment Rate and Inflation Targets Before “Raising” Short-term Rates. • Poised for Summer of 2014 but Most Likely will be Late-2015 • Challenge: Trying to Push up Rates When Consumers Remain on Sideline • Challenge: Disincentive to Credit Mkts by Having a Steeper Yield Curve • GREATER PRESSURES ON LOAN AND INVESTMENT SPREADS • Earnings have greater exposure to market spreads than from nominal rates • Market liquidity has greatest impact on cost of funds • Expectation Suggests Continued Mismatch in Loan/Share Growth • EXPECTATION REFLECTS ANOTHER STRONG OUTLOOK FOR SHARE GROWTH • Share Growth Follows Household Disposable Income • Disposable Income Expected to Increase Again in 2014 • Suggests Share Growth in 2014 will Equal or Outpace 2013 • Lessens Upward Pressure on Cost of Funds in 2014

  17. IMPACT ON INTEREST RATES INTEREST RATE FORECAST “Caveat Emptor” 2013 2014 2014 2nd Half 1st Half 2nd Half Nominal Rates- Fed Funds Target 0.18% 0.18% 0.18% 2yr US Treasury 0.33 0.50 1.00 5yr US Treasury 1.56 1.68 2.05 10yr US Treasury 2.65 2.70 3.05 Relative Spreads- FF to 2yr- 0.15% 0.32% 0.82% 2yr to 5yr- 1.23 1.18 1.05 5yr to 10yr- 1.09 1.02 1.00 FF to 10yr- 2.47 2.52 2.87 Other Rates- Avg Fixed Rate Mortgage 4.60% 4.65% 5.00% Prime Rate 3.25 3.25 3.25 Source: Bloomberg, Mortgage Bankers Association, FTN

  18. IMPACT ON CREDIT UNIONS Large Credit Unions Control 67% of the Assets but are Only 6%of the CUs Source: NCUA

  19. IMPACT ON CREDIT UNIONS Growth Limited to 22% of Credit Unions Source: NCUA

  20. IMPACT ON CREDIT UNIONS Collectively: 6% of Credit Unions had +9% Loan Growth 94%of Credit Unions had -2.4% Loan Growth Source: NCUA

  21. IMPACT ON CREDIT UNIONS Larger Credit Unions have Higher Concentration of Real Estate Loans Smaller Credit Unions Limited or Suffered “Self-Inflicted Restrictions” REAR ESTATE CONSUMER Source: NCUA

  22. IMPACT ON CREDIT UNIONS The Industry has Lost Significant Market Share in Consumer Loans Particularly in Non-Revolving Loans Source: Board of Governors of the Federal Reserve System

  23. IMPACT ON CREDIT UNIONS Source of Growth In Assets Growth is Consistent with Trends in Consumer Disposable Income and Segmentation Source: NCUA

  24. IMPACT ON CREDIT UNIONS Rising Allocation of Non-term Shares Higher Allocation in Smaller Credit Unions Source: NCUA

  25. IMPACT ON CREDIT UNIONS Mismatch Between Loan and Share Growth has Impacted Cash & Investment Allocations Higher Allocationin Smaller Credit Unions Source: NCUA

  26. IMPACT ON CREDIT UNIONS Weak Loan Demand Lowered Asset Yields Lower Provisions Have Offset Lower Nominal Rates Allocation Of Non-term Shares Supported Cost of Funds NET ASSET YIELD COST OF FUNDS Source: NCUA

  27. IMPACT ON CREDIT UNIONS Earnings Are Improving Smaller Credit Unions Nearing Fixed Cost of Ops <$25M: - 3% Assets & 53% of CUs - 40% have neg-ROA in 2013 (vs 28% of industry) - Of these, avg ROA is -0.15% Source: NCUA

  28. RISK & MANAGED GROWTH STRATEGIES MANAGED GROWTH STRATEGY Case Study: Total Assets: $1.2-billion Net Worth: $122-million Net Worth Ratio: 9.6% Capital Strength: “Well-Capitalized” Net Worth Total Assets Net Worth RatioMaximum GrowthMinimum Growth What Asset Size does Current Net Worth Support - Assuming 8.0% Minimum Net Worth Ratio? 8.0% $1,529,411 +21.8% $122,355 +0.0% How Much Would Net Worth Have to Grow to Reach 10.0% Net Worth Ratio, Given: 5.0% Growth in Total Assets 10.0% $1,321,739 +5.0% $132,174 +8.0% 8.0% Growth in Total Assets 10.0% 1,359,503 +8.0% 135,950 +11.1% 10.0% Growth in Total Assets 10.0% 1,384,679 +10.0% 138,468 +13.2% Does Asset Growth Correlate to Net Worth Goals?

  29. RISK & CONCENTRATION MANAGED RISK EXPOSURE Not All Risks Are Equal Other Risks Relatively Manageable and Can be Balanced to Absorb Overall Exposure Credit Risk Greatest Impact on Earnings and Equity IRR CREDIT LIQ OPS

  30. RISK & CONCENTRATION MANAGED RISK EXPOSURE Not All Risks Are Equal The lower the Credit Risk…….. But the greater amount of Liquidity Risk…… The greater amount of IRR exposure can be absorbed The less amount of IRR can be absorbed IRR IRR OPS LIQ LIQ OPS CREDIT CREDIT

  31. RISK & RELATIVE VALUE MARGINAL BENEFIT OF CURRENT RELATIVE VALUE Maximum 5-year Horizon – Current Environment Shorter/Longer Duration? Yield Difference & Assessment Minimum Reinvestment Either Or Impact on Earnings Horizon Rate Req to Break-even OPTION #1…… Investment: 2yr MBS 4yr MBS Rate: 1.59% 2.25% (0.66)% 2yrs from now, rate for at least Duration: 2yrs 4yrs ($13,200) over 2yrs 4yrs next 2yrs must average 2.91% OPTION #2…… Investment: 2yr MBS 6yr Auto Loan Rate: 1.59% 3.50% (1.91)% 2yrs from now, rate for at least Duration: 2yrs 3yrs ($38,000) over 2yrs 3yrs next 1yr must average 7.32% OPTION #3…… Investment: 3yr Callable 15yr FRM Rate: 1.04% 3.75% (2.71)% 3yrs from now, rate for at least Duration: 3yrs 5+yrs ($81,300) over 3yrs 5yrs next 2yrs must average 7.82% OPTION #4…… Investment: 3yr MBS 30yr FRM Rate: 1.65% 4.50% (2.85)% 3yrs from now, rate for at least Duration: 3yrs 5+yrs ($85,500) over 3yrs 5yrs next 2yrs must average 8.78% IMPACT ON REQ RATE OF RETURN/ CURRENT EARNINGS VS PROBABLITILIES?

  32. RISK & RELATIVE VALUE MARGINAL BENEFIT OF LIQUIDITY/DEPLOYMENT IN CURRENT ENVIRONMENT Case Study: Total Assets: $367-million Net Worth: $45-million Loans-to-Assets: 34% STRONG PROFILE MINIMAL IMPACT DOES THE MARGINAL IMPACT OF SURPLUS CASH LESSEN/ELEVATE A “SENSE OF URGENCY” OR MATERIALLY IMPROVE FINANCIAL PROFILE?

  33. RISK & RELATIVE VALUE MARGINAL BENEFIT OF LIQUIDITY/DEPLOYMENT IN CURRENT ENVIRONMENT Case Study: Total Assets: $43-million Net Worth: $3.1-million Loans-to-Assets: 49% WEAKER PROFILE GREATER IMPACT DOES THE MARGINAL IMPACT OF SURPLUS CASH LESSEN/ELEVATE A “SENSE OF URGENCY” OR MATERIALLY IMPROVE FINANCIAL PROFILE?

  34. RISK & EARNINGS MARGINAL SPREADS GENERALLY WIDEN WITH RISING RATES WILL MARGINAL IMPACT ON ASSET YIELDS OUTPACE COST OF FUNDS?

  35. RISK & EARNINGS RATE SENSITIVITY IN A RISING RATE ENVIRONMENT Case Study: Total Assets: $367-million Net Worth: $45-million NTS-to-Total: 84% MMkt Rate Sensitivity Never Went Higher than 40% Drafts Reg Svgs MMkt Chg in Fed Funds NTS Rates Kept Declining when Fed Funds Rate was Rising 100bps! No Increase for First 125bps Didn’t Raise Reg Savings Rates Until After Fed Funds Had Increased 275bps …2% Rate Sensitivity +0.05 +2.75 Chg in NTS Rate Chg in Fed Funds 2% *Jan 2001 to Mar 2004

  36. RISK & EARNINGS RISING RATE RISK EXPOSURE TO ANNUALIZED EARNINGS Case Study: Total Assets: $367-million Net Worth: $45-million NTS-to-Total: 84% NTS Rate to NTS Rate Projected Fed Remain Income @ Change in Funds Neutral 100% RSF NTS Rate Change in Interest Rates +100bps +28bps +100bps +14bps Dollar Impact on Earnings (000s) - - $0 $(1,969) $383 Pct Impact on Net Interest Income - - 0% -27% +5% Disconnect Between CU and Examiners Minimum Exposure

  37. STRATEGIC OUTLOOK FOR CREDIT UNIONS • Little movement in Short-term rates….volatility in longer-term rates through late-2015…. Rate environment tied to DROP IN UNEMPLOYMENT and corresponding INCREASE IN CONSUMER SPENDING BEHAVIOR. • Member sentiment still centered around JOB INSECURITY…this tempers spending behavior and creates a Market Frenzy phenomenon. • Loan and Share Growth in 2014 will be SLIGHLTY BETTER than 2013. • Challenges: ...Develop separate plans for existing and prospective members • …Offer products which our members are interested vs market driven • …Reach selected membership where demand is greatest • …Outreach the “Millennials”

  38. STRATEGIC OUTLOOK FOR CREDIT UNIONS • Think MARGINAL SPREAD rather than MARGINAL YIELD….this will show greater value in today’s loan/funding environment than perceived. • Determine whether the VALUE LOST FROM CURRENT EARNINGS is greater/less than the VALUE EXPECTED FROM FUTURE EVENTS….shows we have greater ability to absorb a rising rate environment. • In this environment, re-evaluate the “sense of urgency” with redeployment of surplus cash – highly dependent on each credit union’s financial profile • Maintain CASH FLOW DIVERSITY in the balance sheet by recognizing relative value options

  39. COMMENTS AND QUESTIONS CONTACT: BRIAN TURNER DIRECTOR, CHIEF STRATEGIST (214) 703-7881 bturner@catalystcorp.org

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