Balancing the need to close loans, make a profit and not suffer from market irregularities has never been more challenging.
I’ve spent almost 39 years in the lending business, and I thought I had seen it all. I have never seen rates, both short- and long-term (as defined by the two-year and 10-year Treasury) go up as quickly as we’ve seen in the last four or five months. I also don’t recall these market-driven rates going up so much faster than the overnight rate and the resulting prime rate. The market has beaten the Fed to the punch, so to speak.
When it comes to pricing, I have lived an especially exciting life. Early in my career, I made small loans at 30% APR at a nationwide finance company. I’ve lived through several inverted yield curves. I’ve seen irrational pricing when lenders could have made more money investing their excess funds instead of lending at their advertised rates—which is also happening today, by coincidence.
A multitude of challenges face credit unions when pricing today! Here are five.
Challenge No 1: The Markets Are Ahead of the Fed
The fact that the financial markets have reacted faster than the Fed is challenge number one. While the average consumer isn’t happy when the Fed raises rates, they understand to a certain extent when loan rates go up as a result. But when rates, like the 30-year mortgage rate, go up 200 basis points in a few months when the Fed has raised rates 25 basis points, consumers are mad, and they don’t understand.
Challenge No. 2: Weird Things Are Happening
The imbalance in the movement of Fed and market-driven rates has created certain irregularities in your pricing. Historically, rates on second mortgages, whether loans or lines, are higher than rates for first mortgages. Yet first mortgage rates (market-driven) are now more than 5%. And home equity rates, based on prime, are now in the high threes and low fours. Yes, while home equity rates are variable and fixed-rate, 30-year mortgages are—well—fixed, this normally doesn’t happen. When it has happened in the past, we’ve seen borrowers try to work the system and do potentially silly things like converting their first mortgage to a variable rate home equity line of credit. Which leads to …
Challenge No. 3: Changes in Consumer Behavior
A big swing in rates leads to a big swing in consumer behavior going beyond the occasional member trying to work the system. One thing that almost never changes in financial services is that homeowners will always want cash from their home. In a matter of a few months, cash-out refinances became home equity loans! Who wants to take $50,000 equity from their home and refinance a 30-year fixed-rate loan, currently at 3% or less, at a new rate of 5%! That’s just stupid unless you listen and read the ads of the clearly desperate mortgage brokers who are trying to stay in business by offering what should be criminally misleading advice. Consumers are again turning to home equity loans for their cash needs, yet few lenders are ready for this. In fact, it’s been my belief that most banks refused to embrace home equity loans as they did before the financial crisis. Good news for Ent, while we didn’t return to the 100% loan-to-value levels of 2005-2007 (much less the 120% LTV loans that some temporarily insane lenders
were offering then), we never lost faith that home equity loans were important to us and our members. Other lenders are desperately trying to reallocate staff among departments and update home equity procedures that, frankly, may have been neglected for a while. We’re fortunate to only be concerned about reallocating staff as well, because we’re prepared for this.
Challenge No. 4: Deposit Rates Aren’t Going Up
How do you solve a problem like Maria? Sorry for the feeble attempt at humor; I’ll blame it on watching The Sound of Music last weekend. The problem really is, do you have to raise rates when deposit rates aren’t going up? After all, virtually all credit unions have way too much money invested on our balance sheets; we need loans! The funny thing is: If you raise rates, consumers typically don’t want as many loans. You raise rates and lose loan volume. In this case, it’s really important to know what’s happening on the “margin” as defined by an economist: If you raise rates to raise your net interest margin and you make fewer loans, how many loans can you lose before you generate less net income? In this case, you can’t “set it and forget it” with rates. You have to monitor loan and application volume daily, weekly and monthly to see if the intended outcome (higher rates, more income) matches the actual outcome.
Challenge No. 5. It’s Hard to Predict the Future
I’ll put on my CFO cap and say this: Who cares if deposit rates aren’t going up? That just means your spreads are staying the same for now if you match up loan and deposit rates. The question to ask yourself about your credit union is, what’s happened over the last two years since COVID-19 caused rates to plummet? If you have any significant mortgages on your balance sheet, as Ent does, you’ve probably seen your net interest margins decline more than lenders who are more heavily invested in consumer loans. In addition, as rates continue to rise, what will your net interest margin look like, especially if deposits continue to flood in and you can’t lend them out? Two words: margin compression.
OK, I Can’t Blame My Humor on a Movie
To be honest, I kind of feel like a boxer who’s been hit in the head way too many times. I am punch drunk. I have members who want rates we advertised last year. I see competitors giving away their money, below investment rates, on auto loans that cost a lot of money to originate. They’d be better off never making an auto loan at their rates. I see sleazy mortgage lenders advertise on social media leading with rates that haven’t been available in 120 days. I have hard-working commercial loan officers who know we want loans and don’t understand why we have to tie their loan rates to benchmark rates like the 10-, 15- and 30-year fixed-rate mortgage. Just call me Stevie Ray Vaughn, because I’m walking the tightrope. I bet you are, too. I hope these reflections on the challenges of loan pricing today help you move forward with success in serving the needs of members and your credit union.
CUES member Bill Vogeney is chief revenue officer and the self-professed lending geek at $8.9 billion Ent Credit Union, Colorado Springs, Colorado.