ELGIN, Ill. -
In this special report focused on lending, analysts shared with the Credit Union Journal a number of strategies and advice for improving loans and loan yield. But there were two common themes expressed: credit unions need to do a much better job of asking their members for their business, and they must take more risks.
Rex Johnson, founder of Elgin, Ill.-based Lending Solutions, said CUs face many challenges, but the biggest is deciding what type of lending they want to do.
"Many credit unions are running into the same problem: the yield they are getting from loans is not keeping up with the yield on deposits members are demanding," he declared. "Historically, credit unions are risk-averse. They do secured loans and chase A-plus paper business. The predictable outcome is they have done a good job of loaning out their money, but they are not making money. With A-plus paper, by the time a credit union offers a low rate, there is no money left over."
A related problem, Johnson continued, is that the cost of funds is up dramatically over the last 12 months, as depositors still want high rates-and are finding those rates elsewhere. As a result, he said, CUs are sitting on a portfolio of good quality loans, but don't have additional funds to lend out because they are not attracting deposits.
The solution, according to Johnson, is to increase loan yield by taking a different tack.
"Credit unions must examine what types of loans they are putting on their books, and at what rate. They must look at mortgages and car loans and other types of loans to see which are profitable. And, in a big switch for credit unions, they must decide how much risk they will take.
"It is not just doing more lending, or getting into new products, the question is how to build earnings to pay deposits."
Johnson recommends CUs explore sub-prime lending. He said the fight with the myriad other lenders in the marketplace for A-plus paper means all are competing on price. "Credit unions have not been taught how to make a loan without having the lowest possible rate. They need a new strategy: they must teach members who have struggled with their credit, gone into bankruptcy or had repossessions, and teach them how to buy automobiles. These people often make bad choices, or they are desperate and don't know choices exist. A 5.5% car loan might be the best rate for the A-plus borrowers, but for the E paper, 14% still is the best possible rate for that type of member. And those members would love the credit union for giving them that loan."
Housing Market Woes Mean New Opportunities
Daniel Penrod, industry analyst for the California and Nevada CU Leagues, said the current interest rate environment, which saw 17 consecutive hikes but remains at historically low levels, still feels "high" to much of the general public. This impression, combined with astronomical highs in the California real estate market, has left consumers unsure which way the housing market will go.
"Interest rates have affected affordability," said Penrod. "In recent years, lenders have introduced a number of exotic mortgage loans outside of the familiar three- or five-year ARMs. There have been interest-only loans, option payments and others. As people have gotten into these loans, they have bought more expensive houses than they could afford. They wanted to tap into the appreciation they were seeing, and they assumed prices would keep going up."
They did not. Formerly red-hot markets in California and South Florida, for instance, began to cool considerably in the fourth quarter of 2005. Since then, prices in the San Diego area have fallen, and most other areas of the Golden State have seen appreciation decline to just 1% to 3%. As a result, Penrod noted people who purchased more house than they could afford-especially those who bought in 2006-are facing big trouble.
This scenario is not limited to California and Florida, of course. Some pockets of the U.S. still are seeing moderate appreciation, other areas have seen prices flatten, while still others are experiencing declines. According to Penrod, the net effect of the housing slowdown is CUs will see a large number of unsecured loans in 2007.
"There will be more opportunities in consumer lending products such as credit cards, auto loans, personal loans and payday lending alternatives. Real estate is not going away, but when people feel wealthier, they spend more. They can adjust up easily and spend more, but adjusting down is not so easy.
"With the 'Wealth Effect,' once people start, they want to maintain their standard of living. It is hard to decrease spending, even if they only felt wealthy for one year."
Credit Cards-Hang on to Portfolio!
The aftermath of the Wealth Effect is that some consumers may have high balances on their credit cards-especially after the holiday shopping period. Penrod said those people might be waiting on their tax return to find "equilibrium," and may even turn to take out a cash loan on their car from their credit union. Another strategy: offer a low APR on credit cards through the end of the first quarter to help their members get through a difficult time.
Similarly, Lending Solutions' Johnson's advice was short and direct: "Credit unions should be pushing credit cards like there is no tomorrow, but instead, they are selling their portfolios. This is like selling the golden goose."
Real Estate Lending
Analysts who spoke with the Credit Union Journal are anticipating that consumers will be looking to refinance their mortgages in 2007, but the exact number will depend on the term of the "exotics," as Penrod noted. The typical interest-only loan has a 12-month period of no interest. The problem: many of those who went the exotic loan route did so because they could not qualify for a conventional mortgage. "Even if the exotic might push them into bankruptcy, they still may not qualify," he noted.
"This year will be a dry run for mortgages," predicted Penrod. "Credit unions will be learning what can be done to offset exotics. And, there will be more specialized savings products. The national savings rate was negative in 2006 for the first time since 1932-33, during the Great Depression. Consumers have spent recent years partying, but there will be an emphasis on savings."
Phil Greer, senior vice president of loan administration for State Employees Credit Union in Raleigh, N.C., and chair of the CUNA Lending Council, said just about every credit union has a home equity offering as part of its menu, but many of those same CUs need to make some changes to their products.
"Make sure it is as competitive as possible and promote it to the membership," he counseled. "Home equity loans promote lending and benefit the members at the same time."
Greer said access to the home equity line of credit should be made as convenient as possible for members, giving the member both a check writing option and the ability to apply for and access the line electronically. "Tell members how easy it will be to access in the future."
As for mortgages, Greer emphasized building relationships with Realtors in the CUs' communities. "Let them know mortgages are available. Realtors play an important part in where a loan gets placed in a purchase transaction."
According to Greer, many credit unions would also be wise to review their mortgage loan origination fee, which typically is 1%. He suggested lowering the percentage, or perhaps capping the dollar amount at $750 or $1,000.
"This will make credit union mortgages more competitive," he said. "We're all going to be struggling to expand our lending, but it is better to have the loan on the books with a lower origination fee."
Allan Stevens, vice president and senior loan officer for Franklin Mint FCU in Broomall, Pa., and a member of the executive committee for the CUNA Lending Council, had several recommendations for improving home equity loans and lines during 2007. He said CUs should review and raise their limits for title insurance and full URAR appraisals, make better use of automated valuation models, and not require title insurance for loans up to a certain amount, (he gave $200,000 as an example) unless there is a compelling reason. In addition, he said credit unions should create a HELOC priced at least one percentage point below prime rate for their best borrowers. The HELOC should require an advance of $20,000 or $25,000 at closing, which creates an account with a balance, he said.
"On both home equity loans and mortgages, offer 100% financing without mortgage insurance for members with average or better credit," Stevens suggested. "SEG credit unions should partner with the HR departments of those companies to provide relocation services for their executives and managers. This is a win-win.
"In general, credit unions should lengthen all loan terms. It will make the payment more affordable for the member and increase interest income-also a win-win. Increasing the average loan size also will make loans more profitable and better satisfy member needs."
Get Focused
Tracy Ashfield, president of Madison, Wis.-based consultancy Strategic Mortgage Solutions, said the operational and tactical elements of mortgage lending are important, but on the strategic level, CUs must determine if real estate products will be important to them, and if so, embrace them.
"Many credit unions offer mortgages as an ancillary product-they offer them because members want them. Or, they got into refinancing when those loans were very popular because rates were low, but now there is no focus."
Marketing and awareness are more important than pricing, she argued. "There is not the awareness there needs to be on the mortgage side. Ask for the business. Make it easy for members to apply. It is more than just relaxed guidelines; credit unions must make the operational side work. Look at it from the member's perspective-is the credit union easy to do business with?
"It is at the core of what CUs do to improve their lending performance," Ashfield continued. "It is too easy to get loans in this world, so doing business with credit unions must be easy. We can lower our origination fee, but if no one knows we do mortgages it doesn't make a heck of a lot of difference."
SECU's Greer is urging credit unions to work with their credit bureau of choice to search their member databases and develop a targeted marketing campaign for lending. He said most credit bureaus will perform this service at reasonable rates, and the bureaus can tell the CU which members have credit scores above certain thresholds, and which have credit cards or home equity loans with other lenders.
"This points out the importance of mining the application," he said. "If a well-qualified member wants a car loan, don't just satisfy that request; spend time with the member and find out if he or she has a first mortgage with equity. Explain how easy it is to refinance the loan from ABC Financial Institution to the credit union."
Unfortunately, Greer said, many CUs have members who are "borderline lazy." They have loans elsewhere, and know they can save money by switching to their credit union, but they procrastinate or do not take the steps necessary to make changes. He suggested the staff should encourage members and demonstrate how painless the process can be-particularly if the member already is applying for one loan.
"All the credit union has to do is ask for the business and emphasize how easy it is. It is a benefit for the member. Staff involvement is important, as is marketing. There are many selling points for why the member's business should be with the credit union, so ask for the business. It is that simple."
Harland Financial Solutions' also emphasized credit unions that are prepared for target marketing and cross selling will be able to improve the relationship they have with their members in the months ahead-and expand their lending offerings.
"It is an important way to position themselves to move into member business lending. Use the existing relationship with members as an entr?e into member business lending," he advised. "Often, revolving home equity lines of credit are actually business loans in disguise. If you are an entrepreneur and want to start a business and need capital, you max out your home equity. Approaching a financial institution before you have a track record is not going to be successful.
"Credit unions have an advantage because they know their members well," Cole added.
Auto Lending
Bruce Callen, president of Teres Solutions, Austin, observed that the loan market of the past 12 to 18 months has been quite variable, depending on the region of the country. In some areas, indirect lending has been waning, causing a shift in focus to home equity. He said he "definitely" thinks margins and yields on indirect lending will get back in line.
"Just because of supply and demand, the spread will get back to about 4% from about 2%, where it has been over the last two years."
The reason: three or four years ago, only the major banks were able to receive loans electronically from auto dealers.
According to Callen, this capability now is offered to credit unions of any size by software from vendors such as Teres Solutions, meaning credit unions can instantly approve similar loans using software that examines credit and debt levels and automatically approves members for whichever loan they qualify.
Johnson of Lending Solutions proposed credit unions collaborate with their local auto dealers to assist members with poor credit in getting into vehicles they can afford, and book the loan with the credit union. He said the CU can host a seminar to teach the members that no dealer financing is needed.
After attending the seminar, the member will go to the dealer and say: "Don't pull my credit report, I have money from my credit union," Johnson explained.
"The credit union helps members get a good deal on the car, and helps improve their credit. There are thousands of members with poor credit who need transportation-it is a huge market," he explained. "Lending Solutions is putting together a program that teaches credit unions how to offer seminars, how to develop a loan package, and how to go to the dealers and negotiate cars at a good price."
Johnson said he sees this as a "new frontier" for CUs and their lending efforts.
"But we have to start marketing to the people who need help. We can do the same thing with homes. People might need 95% or even 100% financing. Of course, the mortgage rate would be higher, around 8% or 9%. This is out-of-the-box thinking, and credit unions have to start thinking outside the box."
Another change Johnson argues is necessary is in indirect lending. He said CUs should rethink their entire strategy and charge different rates to members and non-members.
"Consider 6% for members and 7.5% for non-members. This still is lower than the banks, and offers an incentive to become members."
Similarly, SECU's Greer called on credit unions to review all loan policies and procedures, and ensure members and staff do not have to jump through too many hoops to complete a loan. "It might not be necessary for all members to dot every 'i' and cross every 't,' depending on their credit history."
Many members do not know which loan products are available, so education is critical, Greer added.
Period of Uncertainty
The California and Nevada CU Leagues' Penrod foresees 2007 to 2008 as an "uneven" time.
For the first time in decades, he noted, there will be no incumbent president and no sitting vice president running for president in 2008. This will create uncertainty in the markets, he predicted. Credit unions should closely monitor the labor market, as the typical credit union serves a geographic area or industry.
If one or both are growing, opportunities are up, but if they are declining, so are opportunities.
"Lending is going back to the normal reasons for it-no longer are people buying a second home to finance their retirement. There will be conventional products for conventional needs. The reason credit unions did not jump on the exotic mortgage loan packages is because, long term, they are bad for consumers. They might dig a pit they can't get out of."
Lending Solutions' Johnson believes many are already digging that pit. "Every credit union is struggling to get 1% ROA, and struggling to get deposits. Charge-offs and delinquencies are ridiculously low. They can't get spreads up without taking risks."
