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Raddon Predictions for 2019

February 28, 2019
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2018 was a good year for the economy generally and for the financial services industry.  We experienced reasonably good GDP growth, especially in the second and third quarters, and we spent the entire year at an unemployment rate of 4% or lower.  In the financial services sector, loan growth continued at a strong pace, to the point that many financial institutions are facing liquidity concerns and for the first time in over a decade are engaged in deposit wars.  Earnings also improved for the majority of financial institutions, a result of improving net interest margins helped by four rate increases by the Federal Reserve.

What does 2019 hold in store for the economy and the industry?  Below are our predictions for the coming year.  As noted in an earlier post, our predictions for 2018 were remarkably accurate.  As you peruse these predictions, consider their potential impact on your organization. 

Prediction: GDP growth in 2019 will be lower than 2018 but not negative. 

There are a number of factors which will drive this, but a major factor is uncertainty.  Continuing threats of government shutdowns as well as trade conflicts contribute to this uncertainty.  Global economic weakness could also influence conditions in the U.S.  The stimulative impact of the reduction in tax rates will be lessened.  Perhaps most importantly, by July of 2019 this recovery will officially rank as the longest in U.S. economic history, exceeding the 10 year recovery from March 1991 to March 2001 during the Clinton and Bush administrations. Interestingly, it will also have the dubious distinction of being the lowest growth recovery in modern times. All recoveries end, and this recovery is at its tail end, which means lower growth.

We don’t expect a recession to happen in 2019, but we anticipate that GDP growth for the year will be less than two percent.

Implication:  Prepare for higher delinquencies and chargeoffs as we head into a pre-recessionary environment.  Use CECL requirements to your advantage to better identify loan portfolio risks.

Prediction: Consumer debt levels will flatten out. 

Recent articles in the popular press suggest that we are re-entering the debt crisis of ten years ago.  A more robust analysis illustrate that this concern is perhaps overblown.  If you examine consumer loan growth since the start of this recovery in June 2009, it has averaged 4.7% per year, which is fairly robust growth.  However, if you back out student loan debt, then consumer debt has risen by only 2.7% per year.  Further, the number of households has grown since 2009 by slightly less than 1% per year.  As a result, growth of non-student loan consumer debt has risen by less than 0.3% per year per household when adjusted for inflation.  What this says is that other than student loans, consumers have not grown their consumer debt at any appreciable level.

We expect this to continue in 2019.  We anticipate a reduction in new car sales in 2019 versus 2018 results, and expect stabilization of credit card balances.  And while we don’t expect a dramatic slowdown in student loan debt growth, it will begin to slow to some degree.  Expect total consumer debt to grow less than four percent next year and total consumer debt less student loans to grow less than two percent.

Implication:  Student loans will continue to crowd out other types of consumer borrowing and hamper the financial status of Millennials and Gen Zs (and their parents).  Continue to diversify your lending efforts and reduce your reliance on indirect lending.

Prediction: Consumer price levels will rise between two and three percent. 

Despite the rapid expansion of the Federal Reserve’s balance sheet since the onset of the financial crisis in late 2007, we have seen little evidence of inflation.  In fact, in examining the GDP Implicit Price Deflator data, in no year other than 2011 have prices risen faster than two percent since this recovery began (final data for 2018 is not yet available). 

We anticipate that prices will rise at a faster pace this year.  Increasing competition for labor will drive up wages and this tends to have a ripple effect on general price levels.  We expect a rate of increase in general price levels between 2.5% and 3.0% for 2019.

Implication:  Be creative in how you attract and retain talent. 

Prediction: Fed rate increases will be limited to one this year. 

In 2018, the Federal Reserve increased rates four times by 25 basis points each time.  This was a dramatic increase; the last time the Fed raised interest rates four times in one year was 2006.  Many if not most prognosticators are predicting that the Fed will stand pat for 2019 – no rate increases – and this is indeed very possible.  The Fed continues to watch the 2 year – 10 year Treasury spread and is unlikely move rates up if it causes the yield curve to invert.

However, we anticipate the economic conditions will stabilize, unemployment will remain very low and inflation will ratchet up. The result will be the Fed increases its target rate in the third quarter.   

Implication:  Examine the profitability of your loan portfolios and price accordingly.  This may be the time to sacrifice some growth in order to improve the profitability of the loan portfolio.

Prediction: Mortgage activity for purchases will be more than 75% of total mortgage volume. 

In 2012 over 70% over mortgage volume was refinance.  How times have changed.  In 2018 refinance activity was less than 30% of total volume.  Three factors are behind this change.  First, rising interest rates have reduced or eliminated the economic value of refinancing for most consumers.  Second, and related to the first, is that almost all who can refinance have done so.  The third factor is the migration of the Millennials into their 30s, the traditional home-buying decade.  The Millennial population is so large that it is impacting the purchase market in significant ways.

We anticipate that purchase activity in 2019 will be higher than it has been in any year since 2006 and will be 2.5 times higher than it was at its nadir in 2011.  We expect that purchase activity will account for more than three-quarters of all mortgage activity.

Implication:  Make sure you have mortgage loan products that appeal to Millennials, and if you haven’t implemented a digital account opening system, put that high on your priority list.

Prediction: Net interest margins will decline due to higher cost of funds. 

A major factor that has helped industry earnings in 2018 is improved net interest margins.  Older, lower rate loans have been replaced with new, higher rate loans; loan volume has increased and replaced generally lower yielding investments; and the cost of funds has not increased appreciably, at least for credit unions and many community banks. 

Expect this to change in 2019.  While loan yields will continue to rise in 2019 as older loans are replaced with new loans, the paucity of rate increases (see above) will limit the increase in loan yields.  At the same time, we are seemingly entering an era of deposit wars in many markets, with increasing levels of competition for deposits.  Increasing generational wealth transfers will also impact deposit rates, as financial institutions compete more vigorously for these deposits which are at play.  The depositor has awoken and the impact on cost of funds will be felt in 2019.

Implication:  Cost of funds management will be more critical in 2019 than any year since 2006.  Create a strategic focus around this area.  Most institutions have a Chief Lending Officer; should you have a Chief Deposit Officer?

Prediction: Branch counts will decline by 2.5% to 3.0%. 

In 2018 branch counts declined by slightly more than 2%, led by the largest banks who, with the exception of U.S. Bank, closed 3% or more of their domestic locations, a few much more than that.  On the other hand, credit unions grew the number of locations in 2018.   It’s important to remember that even with these branch closures, the number of banks and credit union branches relative to population remains at very high levels historically, a result of rapid branch expansion in the 1990s and early 2000s.

We expect this trend to continue in 2019. The largest banks will continue to shed physical locations at a rapid pace, reducing market redundancies and closing locations that are not economically viable.  They will continue to push the consumer on the digital path and by this reap the rewards of lower expenses and higher efficiencies.  The increasing mobile-centricity of consumers will support this trend. Remaining branches will continue their migration from transaction hubs to sales and service centers.   

Implication:  Continue to rationalize your branch system.  Do you have the right locations and the optimal branch designs? Do you have the right people in your branches doing the right things and measured with the right metrics?

These are our predictions for 2019.  Let’s see how accurate they are.