How loan trading can help credit unions in challenging times
Since the COVID-19 pandemic began sweeping through the United States, the economic outlook has grown more uncertain almost by the day.
Credit unions are stepping up to serve their members in an increasingly stressful financial climate, while grappling with disruptions across multiple loan products.
When the four biggest U.S. banks reported first-quarter earnings in April, analysts noted a substantial increase in loan loss reserves as the banks prepare their balance sheets for what could be a massive wave of defaults.
Meanwhile, loan originations have taken a hit. Auto lenders, for example, are facing a challenging outlook as consumers postpone car purchases. Retail auto sales were 61% lower in the last week of March than J.D. Power had projected prior to the coronavirus outbreak.
We unfortunately should not expect these trends to reverse in the near future. As a result, many CFOs and chief lending officers are feeling the pressure to reduce risk and rebalance their loan portfolios to ensure their credit unions can maintain financial stability through this challenging period.
Loan trading, particularly between credit unions, offers one potential path to achieve a portfolio that aligns with evolving risk preferences. Purchasing and selling loans with trusted credit union partners can help balance risk, generate income and set the stage for future growth. Amid the many challenges facing financial institutions today, loan trading can help credit unions not only survive, but prosper through the downturn — and ultimately better serve their members.
Reasons to consider loan trading
Approximately half of the nation’s credit unions are active in loan trading, according to call report data from the National Credit Union Administration. The practice appeals to institutions large and small, with diverse memberships and goals. Additionally, credit unions with either low or high loan-to-share ratios can stabilize their ratios by trading loans.
Loan trading offers several benefits that are particularly relevant in today’s challenging environment. Purchasing loans from another institution can help a credit union experiment with new products or diversify risk by increasing exposure to different geographies or asset classes.
Beyond geographic diversification, the practice can also spur overall loan portfolio growth without the associated operational costs of hiring new originators. If, for example, a credit union would like to own and service RV loans, that credit union may want to consider purchasing a portfolio of such loans from a trusted partner, rather than putting forth the upfront investment to originate the business.
Some institutions also engage in loan trading to manage concentration limits. Typically, this important regulatory balance is achieved by selling loans when the credit union is too exposed to one product type, such as auto or consumer loans. Just as important, selling loans can be a powerful path to generating non-interest income at a time when financial markets are under strain.
Preparing for a loan trade
If a credit union decides that loan trading can help achieve its goals, an important first step is to develop a purchase or sale plan that outlines the types and sizes of loans it is looking to trade. The organization will also need to develop a pricing model or seek outside services from a financial consultant or credit union service organization to create one. Alternatively, partnering with another credit union who has experience with loan trading can enable the sharing of best practices.
Lining up the right team is imperative as well — including experienced staff with insight into loan pricing and performance, and legal support around agreements and documentation. Be sure to determine who will be responsible for remittance reporting and reconciliation. There are many state and federal regulations around loan trading, and it’s important for staff to be familiar with those regulations. Other credit unions who have experience in the secondary markets can also be a good source of advice.
Tips for finding a trading partner
For many executives, talking with counterparts within your existing credit union network can be a clear path to finding a trusted partner for your loan trading program. A fruitful way to broaden contacts is to attend industry conferences and events.
During the age of social distancing, when in-person introductions will be limited in various ways for some time, online forums can be another venue for initiating conversations around loan trading. Various industry groups have a host of councils and networking groups filled with credit union professionals who are receptive to discussions on this topic.
Direct relationships with credit union partners can allow for transparency, quicker execution and reduced trading costs. Another path is to work with a broker who can match you up with other credit unions who are looking for trading partners. In addition to connecting you with a larger pool of possible counterparties, brokers can also provide access to market data and offer the benefit of a singular point of contact for your loan trading program.
Loan trading is a team sport
It takes a team to establish a loan trading program, including both internal staff and a reliable network of credit union partners. In the process, you’ll build relationships and learn best practices from other institutions, amplifying the benefits to your organization.
As we all navigate the challenging path ahead, it’s important to consider the many ways we can help each other come out of this period ahead. Loan trading is a unique way we can partner to create a better future for all our members.