American households are beginning to receive some good news about the severe economic downturn: Interest rates on mortgages and consumer loans are falling. Rates on trillions of dollars of existing bank loans owed by households are now above current market rates, and interest rates are likely to fall more. The result will be a refinancing bonanza for smart credit unions wishing to expand their loan portfolios.
During most economic downturns, interest rates drop. This downward move in the current recession was delayed and distorted by the unprecedented freeze of national and global credit markets. Many financial institutions stopped making loans, and sub-platinum consumers fortunate enough to get loans often had to pay extraordinarily high rates. Alarmed governments and central banks around the world responded to the credit crisis by pumping hundreds of billions of dollars into credit markets and by guaranteeing key debt instruments. As a result, credit markets are thawing, and the usual recession-period pattern of declining interest rates is finally emerging.
Mortgage loans are one example of the potential refinancing opportunity ahead. When the Federal Reserve recently announced that it will buy up to $500 billion of mortgage-related securities, it stated that its goal is to drive mortgage rates down and to keep them down. In unusually clear language, it said, "This action is being taken to reduce the cost and increase the availability of credit for the purchase of houses, which in turn should support housing markets and foster improved conditions in financial markets more generally."
If the Fed succeeds in lowering mortgage rates, it will trigger a refinancing stampede that will stimulate the broader U.S. economy. Mortgage rates are already dropping before the Fed's program is implemented, and mortgage refinancing is up. The positive rate spread of nearly 300 basis points between 30-year first mortgage and 10-year treasury rates leaves ample room for downward adjustment. William H. Gross, highly respected managing director of bond giant PIMCO, expects 30-year mortgage rates to drop to somewhere between 4.5% and 5%. Other experts expect rates to settle somewhere just over 5%, and there are rumors Treasury is contemplating programs targeting a 4.5% rate.
Rates on auto loans, credit cards, and other loan products are also under pressure as the economic downturn continues. Like mortgages, they are likely to provide outstanding refinancing opportunities. A competitive bonus for credit unions seeking refinancing business is the tendency of many traditional non-CU players in these non-mortgage markets to resist lower rates because they are trying to recoup losses incurred on previously-made loans that have gone bad. To be sure, economic downturns tend to add risk to the loan portfolios of all financial institutions. A credit union, however, does not need to lower its credit standards to have a productive refinancing program.
Frequently, a refinanced loan is made to a known credit union member who continues to have a good credit rating. The member simply possessed a bank loan that once was appropriately priced, but now it is overpriced due to changes in the interest rate environment. Down payments on mortgages are also likely to rise, thus enhancing collateral quality.
There are five reasons why credit unions are uniquely positioned to take advantage of the refinancing boom:
* Credit union members like and trust CUs more than any other type financial institution.
* Refinanced loans including those made to existing members are likely to be new business for credit unions. More than 90% of the potential mortgages now held my members and the majority of other consumer loans that are refinancing candidates are not presently on the books of credit unions. Though credit unions are liked, trusted and price competitive, their members are "disloyal" borrowers and obtained most of their previous financing from other institutions.
* Many competitors have departed the marketplace or are badly wounded.
* Most credit unions are more than adequately capitalized despite the economic downturn.
* CUs offer most of the mortgage and consumer loan product types that are subject to refinancing. Furthermore, they have links to networks that will purchase many of the mortgages and other loans that they refinance.
Three primary reasons explain why many CUs will miss much of the refinancing boom:
* The biggest problem is the sizeable decline in real estate values in some communities. Homeowners with negative equity are usually not good refinancing prospects. (Nevertheless, a sizeable number of homeowners in every market have positive equity and would benefit from a refi.)
* CUs are typically below-average marketers, and they often lack good cross-selling skills.
* Credit unions are relatively slow in reacting to marketplace changes and opportunities because they are overly cautious.
Credit unions should alert their members that major mortgage reductions may be around the corner, and that their credit union will be able to save them big money when the rates drop. Credit union staffs should prepare for this opportunity and welcome general inquiries from members.
Cross-selling skills are critical here, as is a refresher course polishing these skills.
Timing is important. Waiting for rates to drop before ramping up capacity and developing action plans is unwise. The refinancing window of opportunity can open and close faster than many credit unions would prefer.
Bob Hoel, is a Fellow, Filene Research Institute and Professor Emeritus, Colorado State University.
