Is your credit union in a challenging liquidity situation?
The economy, and its many intricacies, can be challenging for even the most seasoned credit union portfolio manager. Because of its tumultuousness, the stage is set for many of us to rethink our portfolio strategies, and possibly to look for new, affordable liquidity options.
It is generally understood that relying on short-term sources of funds to invest in longer-term loans and investments can lead to future liquidity and interest rate-risk due to duration mismatch.
Therefore, all credit unions should carefully and regularly monitor their liquidity levels and develop (or re-develop) their liquidity strategy.
This is easier said than done, however it's VERY important for your credit union's long-term financial health and stability.
Before I get into the 'Golden Egg' opportunities loan participations may provide to your credit union, as a refresher let's briefly review some important ratios that can affect your credit union's profitability.
Loan-to-Asset Ratio.
Your credit union should strive to maintain a loan-to-asset ratio where it can meet members' loan demand, and still meet its other liquidity needs. High loan-to-asset ratios (e.g., in excess of 80%) may indicate that your credit union cannot meet all these needs, especially if other funding sources are limited.
While loan repayments provide your credit union with a flow of funds, these funds are generally reinvested in future loans.
If your credit union uses loan repayments to meet other liquidity needs (such as share withdrawals or to repay borrowings), it may not be able to satisfy member loan demand.
This could jeopardize your credit union's reputation, which could result in members turning away from your credit union for their borrowing and other financial needs.
Loan-to-Share Ratio
Your loan-to-share ratio is also a good liquidity indicator. The higher the ratio, the greater the likelihood your credit union will need to obtain external funding sources.
Generally, a ratio in excess of 100% is indicative of high liquidity risk; therefore, your credit union would need to determine how management is managing its liquidity needs.
Capital Ratio.
The loan-to-share ratio is similar to the loan-to-asset ratio but focuses only on the ability of your credit union to fund loans from member and non-member shares.
It excludes funding from borrowings and capital. So, your credit union should look at its capital level and its ability to manage borrowed funds to determine if a high loan-to-share ratio indicates a problem.
Additionally, if your credit union is relying on short-term non-member shares, you should examine whether it can maintain its loan volume in light of the higher volatility of these shares.
So, what EXACTLY is a loan participation?
By selling up to 90% of a loan, or pool of loans, your credit union will in turn receive cash.
Your credit union retains ownership of a minimum of 10% of the loan(s). A loan participation allows your credit union to maintain the servicing, and therefore the important member relationship, while freeing up funds so you can continue to make additional loans to your members.
Types of loans that are generally eligible for purchase by your corporate credit union include residential mortgages, commercial real estate loans, home equity loans, auto loans, recreational vehicles, and taxi medallion loans.
What makes loan participations a "Golden Egg?"
As a loan provider, your credit union needs to ensure that liquidity is available WHEN your members need it. If your credit union uses loan repayments to meet its other liquidity needs, it may not be able to satisfy member loan demand.
This is important because it could jeopardize your credit union's reputation. Loan participations offer your credit union an alternative liquidity option to borrowing.
In a rising interest-rate environment, such as we are in now, your credit union can use loan participations to help manage its interest rate risk.
If your credit union has been relying on member shares to fund longer-term fixed-rate loans, rising rates could result in shrinking spreads. Selling off some of these loans, or participating a portion of them, allows your credit union to re-loan the money at higher rates, thereby offsetting some of your interest rate risk.
Important to note here is that your credit union will continue to service the loans, thus maintaining the member relationship.
Loan participations are completely invisible to your members. In addition, your credit union will generate fee income as the buyer pays a servicing fee.
Not only can loan participations provide an additional source of liquidity, they can also be a reliable outlet for excess loan production.
In addition, a loan participation could help mitigate your credit union's credit and interest rate risk because it will hold only a small percentage of each loan.
Loan Participations At-A-Glance
Loan participations include the following features:
* Alternative source of liquidity;
* Your credit union maintains servicing rights; and hence the member relationship;
* Servicer receives fee income;
Benefits:
* Your credit union can sell up to 90% of a loan, or pool of loans; your credit union keeps a minimum of 10%;
* Completely invisible to your members; nothing changes for them; and
* Opportunity for your credit union to earn fee income.
Lisa Malone is VP-Lending at Empire Corporate and can be reached at lmalone
