Through tried-and-true revenue generators, such as mortgage and other consumer loans, or accounts for emerging businesses, such as start-up financing for cannabis growers, credit unions are poised to emerge out of their recent slump. For much of the current decade, the Credit Unions industry in Canada has dealt with difficult operating conditions, resulting in tepid annualized revenue growth of 0.7% over the five years to 2018. Commercial banks, particularly the Big Five, have absorbed an increasingly large portion of business in Canada. This has hampered credit unions, as growth opportunities have been sparse in most provinces. All hope is not lost, however, as a shifting operating landscape presents the industry with potential key opportunities to grow.
Credit unions are not typically thought of as driving emerging industries forward, yet that is exactly what they are positioned to do, if they take the chance. For years, cannabis companies have sought financing to fund their ventures, but have been held back by both negative stigma and strict regulation. The tides have begun to turn, however, as sentiment regarding recreational marijuana has steadily improved each year. For instance, researchers at Dalhousie University found that nearly 68.0% of Canadians in 2017 supported legalization of recreational marijuana usage. In conjunction with the likely legalization of recreational marijuana this summer, expectations for the emerging industry are higher than ever. However, businesses generally must finance their operations through some mix of equity and debt. Since many banks are reluctant to finance cannabis growers, often citing the inherently risky nature of new business models, there is an opportunity for credit unions to step in and satisfy demand for financing.
One such credit union that has been at the forefront of servicing the cannabis industry is Alterna Savings and Credit Union Ltd. CEO Rob Paterson estimates that two-thirds of licensed producers bank with Alterna. The credit union provided start-up financing to Canopy Growth Corporation in 2015; it is now the largest cannabis producer in the country. In 2016, the first full year of providing services to cannabis growers, the credit union’s profits nearly tripled. Despite declining in 2017, net income was still double what it was in 2015. Yet, there remains room for growth; according to Statistics Canada, there were 97 licensed cannabis producers in March 2018, as opposed to 41 a year prior.
With legalization around the corner, the influx of growers will likely only continue rising. As they enter the market, credit unions have an opportunity to establish relationships and secure customers. The appeal of providing services to growers is not just financial, however. For instance, the Canadian Credit Union Association (CCUA) indicates that “the credit union difference is all about service – to members and our communities,” and that “credit unions’ purpose is to provide service to members and to contribute to your economic, social and environmental well-being.” Public sentiment regarding marijuana has continued to enhance, in part because of the perceived health benefits associated with its usage, placing marijuana financing at the crux of credit unions’ credo of community responsibility and profitability.
Credit unions have an opportunity to not only do well financially and improve credit union profit margins, which IBISWorld projects to reach 12.1% in 2018, but to also benefit communities by servicing businesses that have wide-ranging support. Time is of the essence, however, as this may be more difficult to do if big banks become more willing to service cannabis companies.
Importantly, the cooldown in the housing market is occurring against the backdrop of rising interest rates. Since July 2017, the Bank of Canada raised its overnight rate target three times. While the target rate has remained unchanged since January at 1.25%, IBISWorld projects the overnight rate to increase markedly over the next few years, stabilizing at 2.5% in 2021. As interest rates rise, the spread between interest charged on loans and interest paid for deposits tends to increase. This signals a reversal of fortune for credit unions and other depository credit intermediaries, as a widening net interest spread signals widening gross margins.
Similar to the composition of aggregate household debt in Canada, a significant portion of issued personal loans are residential mortgage loans. For instance, according to the latest data available, 63.6% of total loans issued by industry leader Desjardins Group are residential mortgages. Considering that Desjardins Group accounts for 48.2% of revenue generated by credit unions in Canada, they are indicative of the industry as a whole.
In both 2017 and 2018, the Office of the Superintendent of Financial Institutions (OSFI) implemented new mortgage regulations to prevent the housing market from overheating. More specifically, the 2018 guidelines require that even uninsured borrowers with down payments over 20.0% must pass a stress test for application approval. Simply meeting contractual obligations is no longer sufficient to gain approval for an uninsured loan; mortgage applicants must have the ability to make payments as if their mortgage rate is the higher of either the five-year benchmark rate or the agreed-upon mortgage rate plus 200 basis points. As a result, declined mortgage applications have skyrocketed in 2018 thus far.
While the new mortgage rules are pumping the brakes on the housing market, there is a silver lining for credit unions; they are exempt from OSFI regulations due to their status as provincially, not federally, regulated institutions. Accordingly, credit unions are well-positioned to absorb some of the demand for mortgage loans in this new regulatory environment, as prospective homeowners who have their mortgage applications denied from banks may resort to alternative mortgage lenders. Yet, credit unions have not increased mortgage originations drastically in 2018. According to Martha Durdin, CEO of CCUA, much of this is due to credit unions’ inherently conservative nature. While some credit unions have voluntarily implemented the new OSFI stress tests, others simply do not have the funds to significantly increase mortgage originations.
Budding expansion opportunities
Credit unions are experiencing a dilemma: how can they attract customers and grow while competing with big banks? While credit unions may be able to plant roots in the rapidly growing cannabis industry, the fledgling industry poses a potential risk that credit unions might not be willing to take. Similarly, while the revised mortgage guidelines may push applications more from banks to credit unions, credit unions may be unwilling to take on relatively riskier customers. Whatever strategy credit unions adopt, rising interest rates are poised to lift all players higher.
Edited by Rebecca Simon. Designed by Anam Baig.
Industry Impact: Credit Unions; Commercial Banking
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