For the past couple of years, most credit unions have been navigating a virtual ocean of liquidity. Now some of those same credit unions may run aground in funding their loan business.
Give credit to the growing economy. Or to the fact that what goes up, must come down. But with proper planning-and the use of tactics such as loan participations-many credit unions can avoid the rocks of low liquidity and stick to the business of lending money to members.
Over the past few years, as the economy stalled and the stock market sank, credit union members pulled their money out of the stock market and other investments and began stashing it in credit unions.
And with loan demand withering in the face of the recent recession and dealer financing, most credit union executives could do little more than watch the money pile up. The problem, at that time, was excessive liquidity.
A New Optimism
The environment, however, has begun to change. And now, uncertainty has given away to optimism. Tax rebates have recharged consumer spending.
Lending has picked up. And the stock market has found new momentum
Indeed, loan-to-share averages have risen rapidly since bottoming out in the first quarter of 2003 at 67.45%. By the third quarter, the loan-to-share ratio stood at 69.69%. CUNA Chief Economist Bill Hampel recently noted that the loan growth in the third quarter of 2003 was the highest third quarter growth rate in nine years.
Meanwhile, the savings growth during the third quarter in 2003 was the weakest in the past five years, he added. Economists predict continued loan growth.
This recent activity began to absorb liquidity at credit unions. And some credit unions are plotting a course for the day when they run out of funds for lending. It is not yet a widespread occurrence. But the economic charts are aligning.
First to feel the impact of tightening liquidity are the credit unions that fared better at lending than others during the recession, including those that are heavily involved in indirect lending. Credit unions with successful indirect programs were able to match off their tide of deposits with the steady stream of lending requests.
For them, the inflow of deposits was not viewed as excess liquidity, but rather, a way to continue growing their lending business. However, as their lending remains steady, their ability to meet loan demand is beginning to diminish as loan growth outpaces deposit growth.
Who Will Feel The Pinch?
While these credit unions may be the first to feel the liquidity pinch, others will likely experience the impact if economic forecasts are correct.
As credit unions begin to address the changing balance sheet dynamics, they may be more likely to consider a new tool to help them retain liquidity as deposits retreat. That tool is loan participation. This balance sheet lever is likely to get wider use during this economic chapter.
One of the reasons is, of course, a growing sophistication among credit unions. Another is that it is easier to get involved in loan participations because corporate credit unions are playing a larger role in the process. A few corporate credit unions have gained broader powers in this area.
And rather than brokering the transaction between two credit unions and taking a piece of the action, some corporates are purchasing loan participation outright. That allows a credit union to maximize the dollar price received on the sale of a loan participation. And because of their size, many can provide a single-source placement for credit unions with large pools of loans.
Most loan participations will fall between $3 million and $10 million. However, some smaller-sized credit unions can participate loans in the range of $200,000 to $500,000. At the same time, Southwest Corporate, can handle participations that exceed $25 million.
Loan participation programs, such as the one offered by Southwest Corporate for instance, are specifically designed to help credit unions sell participations in automobile loans and first lien mortgage loans. Some of the loan participation programs allow credit unions to participate up to 90% of their loan portfolio.
The purchase price and terms are determined on a case-by-case basis, based on current market conditions, yields on the loan portfolio, servicing costs and related risk factors.
A Secondary Benefit
There is a secondary benefit provided by loan participation that might appeal to some credit unions as well.
Aside from providing liquidity to meet additional lending needs, a loan participation program can help a credit union manage interest rate risk exposure while continuing to earn servicing fee income.
Determining if your credit union is a candidate for loan participation may be rather intuitive. However, there is the cost of liquidity that needs to be determined.
Once analyzed, if reducing risk and putting more liquidity in the coffers so that it can be lent out makes good sense for your credit union, how do you prepare for participation? The first three steps to consider include:
* Reviewing the loan participation agreements. An attorney should review these documents to make sure your credit union is getting what you expect.
* Check on internal reporting requirements. Most loan participation agreements require monthly reports on the loan pool's performance. Find out what is necessary and how that will happen.
* Identify potential loan pools to sell for participation. You might sell a block of loans made during a recent time period or you may decide to designate a certain portion of new loans to be part of a future participation package.
Of course, loan participation is one of several ways to help credit unions generate liquidity. The other well-known options include: increasing deposits or borrowing money.
Examining Your Options
However, of these options, increasing deposits may be the least attractive. While it sounds simple, attracting enough deposits to meet growing loan demand might require premium rates.
Yes, the goal can be accomplished, but not without a significant increase to the cost of funds. For instance, credit unions can typically borrow funds from Southwest Corporate at rates similar to current wholesale market rates. Current three-year wholesale funding (borrowing) rates are approximately 2.75%.
A credit union offering a three-year certificate of deposit at a current rate significantly above 2.75% may be paying a premium to attract liquidity.
Borrowing, particularly in the current rate environment, may present a more attractive option. And that is just what is happening. Indeed, an increase in term lending became noticeable at corporate credit unions in the second quarter of 2003.
Credit unions are taking advantage of the low-rate environment to lock in lower funding cost in this low rate environment.
Some are giving up margin now, anticipating that retail interest rates will be going up in the coming months.
Never Having To Say 'No'
Corporate credit unions have made rates for term loans more favorable in recent years. In the past, a few credit unions turned to the Federal Home Loan Bank to meet their long-term borrowing needs.
However, rates charged by corporate credit unions have become more competitive, and corporates are more flexible in the types of collateral they can accept.
Credit unions have earned the reputation as the best place for members to go when they need loans.
By and large, credit unions say "yes" when members come looking for loans. Proper planning can help credit unions avoid having to say "no" simply because they don't have the money to lend.
Bruce Fox is senior vice president and chief investment officer with Southwest Corporate Credit Union, Dallas. He can be reached at 972-861-3000.
