1. CUNA Mutual Group Proprietary Reproduction, Adaptation or Distribution Prohibited © CUNA Mutual Group Economic & Credit Union Monthly Update May 2015 Table of Contents Economy………………………….Page 2-7 Credit Union Loans….…..………Page 8-17 Credit Union Investments……….Page 18-21 Credit Union Savings……………Page 22-31 Credit Union Earnings……….….Page 32-43 Credit Unions and Members…...Page 44-47 Economic & CU Forecast……....Page 48-49 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 To access this monthly update go to: www.cunamutual.com

2. 2 Economics Section Gross Domestic Product Labor Market Inflation Interest Rates Auto and Home Sales

3. 3 The economy grew at a 0.2% annualized rate in the 1 st quarter, below the long-run natural rate of 2.5%, due to falling energy investment, the west coast port strike, adverse winter weather and the rising value of the dollar. Final sales subtracted 0.5 percentage points but the change in inventories contributed 0.7 percentage points. Economic growth should accelerate to 3.0% in 2015, and 3.3% in 2016, above the 2.4% pace set in 2014. The economy is operating with a -2% “output gap” but is rapidly approaching its potential level of output. The Federal Reserve will therefore begin increasing the fed funds interest rate later in 2015. Rising Economic Growth and Falling GDP Gap

4. 4 The labor market added 223,000 jobs in April, and 3 million during the last 12 months. Average hourly earnings rose a modest 0.1% in March and 2.1% during the last year. Expect monthly job gains to average over 250,000 in 2015, bringing the unemployment rate close to the natural rate of 5% by year end. The unemployment rate fell to 5.4% in April, which corresponds to 8.5 million unemployed workers. Underemployment fell to 10.8%. Strong employment gains will increase household incomes, confidence and desire to borrow and spend. Expect loan growth to accelerate in 2015. Strong Employment Gains Close In On Full Employment

5. 5 Headline inflation was 0% during the last 12 months while core inflation was 1.75% below the Federal Reserve’s target of 2%. There are 5 factors keeping inflation low: the negative output gap leads to idle capacity, the unemployment rate above the natural unemployment rate keeps wage growth slow, a rising value of the dollar keeps import prices low, the “commodity super cycle” keeps commodity prices low, the low oil price keeps many other prices low and bond markets are not expecting higher inflation. Low inflation will keep cost of living adjustments below long term trends and interest rates low. Inflation Below Target and Falling Inflation Expectations Nominal Rates Expected Inflation Real Interest Rates Nominal Interest Rates = Real Rates + Expected Inflation

6. 6 The Federal Reserve will raise short-term interest rates by 1.25 percentage points per year for 3 years starting in the fall of 2015. Interest rates will “normalize” in 2018 at levels below previous plateaus due to lower real interest rates and lower expected inflation. The 10-year treasury interest rate will remain below 3.0% through 2015 due to a low demand for money (low supply of bonds) and a higher supply of money (higher demand for bonds) than we have seen in the last 30 years. The short-end of the yield curve (out to 3 years) steepened over the last month and over the last year, encouraging more investments in the 1-3 year range and boosting net interest margins. Falling Interest Rates and Steeping Yield Curve

7. 7 U.S. vehicle sales fell to a 16.5 million unit seasonally-adjusted annualized basis in April, down from 17.1 million units in March, due to a rise in housing starts and weaker demand from the energy sectors. Sales were still up 3% year over year. Low gas prices are driving sales of light trucks which accounted for 55% of vehicle sales, the highest share in 10 years. Consumer fundamentals remain favorable to drive sales into the future. Expect car sales to increase 4% in 2015 to reach 17 million units sold and decelerate to 16.5 million in 2016. Existing home sales fell 3.3% in April, falling to a 5.04 million annual rate, but are still up 6.1% from April 2014. Home inventories remain tight leading to home prices rising 5% in 2015. Strong Auto Sales and Rising Home Sales

8. 8 Credit Union Loans Section Total Loans Loan Quality New Auto Used Auto Credit Card Home Equity Fixed-Rate First Mortgage Adjustable-Rate First Mortgage

9. 9 Expect loan balances to grow 11% in 2015 and 10% in 2016 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 is rather large. In the last 12 months, credit unions with assets greater than $1 billion reported an 11.9% increase in loan balances versus credit unions with assets less than $20 million reported loan growth of only 1.8%. Rapid Credit Union Loan Growth

10. 10 The credit union loan delinquency rate (loans two or more months delinquent as a percent of total loans outstanding) fell to 0.74% in March, down from 0.81% in March 2014 and less than half the 1.88% reported in February 2010. Today’s delinquency rate is only 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 0.53% in the fourth quarter of 2014 up from 0.47% in the third quarter as CUs clean up the balance sheets, but is down from 0.57% from the fourth quarter of 2013. Improving Credit Quality As Unemployment Falls

11. 11 Credit union loan balances grew at a 11% seasonally-adjusted annualized growth rate in March, similar to the pace set during the credit boom of 2004. March’s seasonal factors usually shave off 0.22 percentage points from the underlying trend growth rate. The strong lending “season” is right around the corner as April through August are the strongest loan growth months of the year. Rapid Credit Union Loan Growth

12. 12 Credit union new-auto loan balances grew at a 24.2% seasonally-adjusted annualized growth rate in March, the fastest pace on record. March’s seasonal factors usually shave off 0.32 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 4% in 2015 to reach 17 million units sold as more pent up car demand is satisfied Rapid New Auto Loan Growth

13. 13 Credit union used-auto loan balances grew at a 14.9% seasonally-adjusted annualized growth rate in March, the fastest pace since September 1997. March’s seasonal factors usually add 0.32 percentage points from the underlying trend growth rate. The used auto buying and lending season begins in March and runs through September. Rapid Used Auto Loan Growth

14. 14 Credit card loan balances grew at a 4.8% seasonally-adjusted annualized growth rate in March, due to low gas prices reducing the amount of credit used at gas stations and members used bonuses and tax refunds to pay down credit cared balances accumulated during December.. March’s seasonal factors usually shave off 1.41 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. Slowing Credit Card Growth

15. 15 Credit union home equity loan balances grew at a 7.6% seasonally-adjusted annualized growth rate in March, due to rising home prices and improving consumer confidence. March’s seasonal factors usually shave off 0.99 percentage points from the underlying trend growth rate as homeowners use tax refunds and bonuses to pay down home equity debt. Home equity loan balances are up 6.8% during the past 12 months due to rising home prices, the improving job market, rising consumer confidence, consumers releasing pent up demand for durable goods, and lower interest rates Rising Home Equity Loan Growth

16. 16 Credit union fixed-rate first mortgage loan balances grew at a modest 7.2% seasonally-adjusted annualized growth rate in March. March’s seasonal factors add 0.46 percentage points to the underlying trend growth rate. Credit union purchase mortgage originations should increase 15% in 2015 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. Modest Fixed-Rate First Mortgage Growth

17. 17 Credit union adjustable-rate first mortgage loan balances grew at a strong 10.1% seasonally-adjusted annualized growth rate in March. March’s seasonal factors usually shave off 0.58 percentage points from the underlying trend growth rate. During the last 12 months, adjustable-rate mortgages balances rose 12.7%, almost twice the 6.8% pace of fixed-rate mortgage balances. Credit unions are placing more adjustable-rate mortgages on their books in preparation of the Federal Reserve raising short-term interest rates in the third quarter of this year. Strong Adjustable-Rate First-Mortgage Growth

18. 18 Credit Union Investments Section Surplus Funds Yield on Surplus Funds Investment Maturities Liquidity flows Surplus Funds Distribution

19. 19 Surplus funds rose to 34% of assets in March, but down from 36.3% in March 2014. Investments as a percent of assets fell over the last 2 years as loans growth accelerated. Loans now make up almost 63% of assets, up from the cyclical low point of 57% set in March 2013. The yield on surplus funds rose to 1.21% in the fourth quarter of 2014, up from 1.19% in the third quarter. Loan yields remain at 4.83%, the lowest in credit union history. With loan balances expected to grow another 11% this year ($76.4 billion), expect surplus funds as a percent of assets to fall below 30% by year end, the lowest level of liquidity since February 2009. Investments Are Falling But Yields Are Rising

20. 20 Surplus funds with a maturity less than 1 year rose to 48.6% in February 2015, up from 46.4% during February 2014. The yield curve slope steepened in 2014 (as measured by the difference between the 3-year Treasury interest rate and the fed funds interest rate) which led to a greater share of investments invested in the 1-3 year maturity bucket. Rising Investment Maturities as Yield Curve Steepens

21. 21 Credit union investment dollars fell -$3.1 billion in March as credit unions paid down $3 billion in borrowings. Credit unions drained their liquidity, however, during the last 12 months to fund a record $71 billion jump in loan balances. The rest of funding for the loan increase came from a $37.8 billion increase in deposits, a $13.8 billion increase in borrowings and a $9.1 billion jump in capital. The Great Recession and the associated corporate credit union goings-on caused a shift in the composition of surplus funds. In 2007, credit unions held 33% of their surplus funds in shares/deposits at corporate credit unions. Today, only 5.6% of cash and investments are held at corporate CUs. Federal Agency Securities Are Lions Share of Investments From 1 month agoFrom 1 year ago

22. 22 Credit Union Savings Section Total Savings Savings Distribution Savings Interest Rates Regular Share Share Draft Money Market Account Share Certificate Borrowings

23. 23 Savings balances rose 4.4% in 2014, up from 3.6% in 2013. This modest underlying trend growth is being fueled by low gas prices, rising household income, strong job growth, and fast membership growth. Savings balances are expected to grow 4% in 2015 and only 3% in 2016 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, credit unions with assets greater than $1 billion reported a 5.2% increase in savings balances versus credit unions with assets less than $20 million reported savings growth of only 0.2%. Slower Saving Growth in 2015 and 2016

24. 24 Regular shares made up 35% of total savings in 2014 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 interest rate in the fall of 2015, expect credit union CD and money-market account interest rates to rise this fall. Short-term Liquid Funds Dominate Savings Mix

25. 25 Credit union savings balances grew at a 5.5% seasonally-adjusted annualized growth rate in March, due mainly to falling oil prices putting more money in members’ pockets. March seasonal factors typically add 1.15 percentage points to the underlying savings trend growth. Credit union saving balances grew 0.41% in March, historically the second fastest savings-growth month of the year due to bonuses and tax refunds being deposited into members accounts. Modest Saving Growth as Gas Prices Fall

26. 26 Credit union regular share balances grew at a 9.5% seasonally-adjusted annualized growth rate in March, due mainly to falling oil prices putting more money in members’ pockets. Seasonal factors (bonuses and tax refunds) typically add 2.26 percentage points to the underlying regular shares trend growth. Rapid Regular Share Growth

27. 27 Credit union share draft balances grew at a 16.4% seasonally-adjusted annualized growth rate in March, due mainly to falling oil prices putting more money in members’ pockets. Seasonal factors (bonuses and tax refunds) typically add 1.08 percentage points to the underlying share draft balance trend growth. Rapid Share Draft Growth

28. 28 Credit union money-market account balances grew at a 3.4% seasonally-adjusted annualized growth rate in March, due mainly to falling oil prices putting more money in members’ pockets. March’s seasonal factors (bonuses and tax refunds) typically add 1.02 percentage points to the underlying money-market account balance trend growth. Slow Money-Market Account Growth

29. 29 Credit union share certificate balances fell at a -2.5% seasonally-adjusted annualized growth rate in March. March’s seasonal factors typically subtract -0.22 percentage points from 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 Resurgent Share Certificate Growth

30. 30 Credit union IRA balances grew at a -2.1% seasonally-adjusted annualized growth rate in March. March’s seasonal factors typically add 0.73 percentage points to the underlying IRA balance trend growth. Falling IRA Growth

31. 31 Credit union wholesale borrowings grew at a 55.5% seasonally-adjusted annualized growth rate in March. March’s seasonal factors (excess savings growth) typically subtract -6.68 percentage points from the underlying borrowings trend growth. Credit unions are turning more and more to wholesale funds to help fund some of the recent surge in loan demand. Resurgent Borrowings

32. 32 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

33. 33 Credit union return-on-equity ratios rose to 9% in 2014, the highest since 2002. 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 2014. Credit unions with assets exceeding $1 billion reported ROE ratios of 9.5%, more than twice that reported by credit unions with assets less than $100 million. Rising Return on Equity

34. 34 Credit union loan growth of 11-10% 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 2015 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 in the fall of 2015 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 Rising Yield on Assets

35. 35 Rising short-term interest rates in 2015 will increase credit union cost of funds from the record low mark of 0.54% set in 2014. 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. Rising Cost of Funds

36. 36 Net interest margins will increase over the next two year due to strong loan growth and rising market interest rates. 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. Rising Net Interest Margins

37. 37 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 2015 and 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 2015 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. Falling Operating Expense Ratios

38. 38 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. Falling Fee Income Ratios

39. 39 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 2015 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. Stable “Other Income” Ratios

40. 40 Provision for loan loss ratios will increase slightly in 2015 and 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 2015, reducing the number of mortgages at risk of foreclosure. Rising Provisions for Loan Loss Ratios

41. 41 Credit union return-on-asset ratio will remain at 0.80% in 2015 and 2016. Rising asset yields – due to faster loan growth and modestly higher market interest rates - will slightly outpace higher funding costs, raising net interest margins. Expect loan loss provision expense to rise but operating expense ratios to fall. The disparity between large and small credit unions return-on-asset ratios remained large in 2014. Credit unions with assets exceeding $1 billion reported ROA ratios of 1%, more than twice that reported by credit unions with assets less than $100 million. Stable 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

42. 42 Credit union capital-to-asset ratios will continue to rise in 2015 and 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 2016, capital ratios will approached the record high set back in 2006. Rising Capital Ratios

43. 43 Asset growth is expected to slow in 2015 and 2016 as deposit growth slows. Asset growth will outpace savings growth by one percentage point, however, due to borrowings rising 30% and capital rising 9%. The average credit union asset growth of 5.6% in 2014 masked a wide growth rate disparity between large and small credit unions. Slowing Asset Growth and Wider Inequality

44. 44 Credit Unions & Members Section Number of Credit Union Credit Union Members

45. 45 As of February 2015, CUNA estimates 6,437 credit unions were in operation, 37 fewer than January. During the last 12 months the number of credit unions fell by 309, above the 301 annual decline set one year ago. The pace of consolidation in the credit union system is accelerating due to the following factors: retiring baby-boomer CEOs, rising regulatory/compliance burden, record low net interest margins, rising concerns over scale and operating efficiency, rising competitive pressures and members’ demand for ever more products, services and access channels Credit Union Consolidation Accelerates Number of CUs March 2015 = 6,437

46. 46 Credit unions should expect membership growth to exceed 3% in 2015 and 2016 due to strong job growth. This will push the total number of credit union memberships to 104.5 million by year end 2015, which is equal to 33% of the total U.S. population. Credit union with assets over $1 billion reported 6.3% membership growth over the last year, compared to less than 1% for credit unions with assets less than $100 million. The 3,038 credit unions with assets less than $20 million reported a 1.6% decline in memberships. Membership Growth Surges

47. 47 Credit union memberships grew at a 4.0% seasonally-adjusted annualized growth rate in March. March’s seasonal factors (households receiving bonuses and tax refunds) typically add 0.16 percentage points to the underlying membership trend growth. Credit union membership growth was on a tear during the first three months of 2015, adding 1,300,000 new memberships versus the 900,000 reported in the first three months of 2014. The membership gain was driven by the 552,000 new jobs created during January through March, according to the Bureau of Labor Statistics, and by the tremendous growth in credit union auto lending Rapid Membership Growth

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50. 50 The Credit Union versus Human Heart Analogy Banks and Credit Unions are to the economy what the heart is to the human body Money  Blood Deposits  Deoxygenated (blue) Blood Loans  Oxygenated (red) Blood (Loans like blood lead to productive outcomes) Loan departments collect information  Lungs collect oxygen Capital  Heart Muscle Banks/CUs Allocate Capital  Aorta Artery Allocates Blood (to Most Productive Use) Toxic Assets/Loans (MBS)  Plaque Banking Crisis  Heart Attack Government Intervention  Defibrillator $2.6 Trill Excess Reserves/Cash  Atrial Fibrillation (Atrium Blood Pooling) (False Economic Signals  Abnormal Electrical Signals)