Being a depository institution alone may not be enough to continue expanding credit unions’ share of the market.
As I look back over my career, it’s pretty clear that there are significant reasons why it helps to be a depository lender—one that takes in deposits and uses them to make loans. Consistency of funding costs and availability can’t be overstated!
An extreme example of how being depository institutions has helped credit unions comes from when CUs made major auto loan market share gains in 2009. At the time, the financial markets made it impossible for the captive finance companies to originate loans at rates consumers would accept and subsequently sell the loans at par.
Looking at long-term examples, Capital One started as a credit card company, then realized it couldn’t consistently grow its card portfolio by securitization (converting loans into marketable securities), so the credit card company obtained a bank charter and sought out deposits. Now Capital One’s a significant competitor for deposits and loans. SoFi, while not a bank, is a recent example of a lender that relied on loan securitization but is now attracting deposits.
As an industry, credit unions are experiencing the highest loan-to-share ratio of all time, with hundreds of credit unions at 100 percent loan-to-share or higher. Most of these are larger credit unions. Having a high loan-to-share ratio doesn’t mean these credit unions are out of money, it just means they’re now starting to lend the cash that is a result of retained earnings less non-interest earning assets, like your physical plant. Credit unions are in this situation because we have been wildly successful as auto, mortgage and commercial lenders.
What keeps me up at night is that this current situation may not be a fluke, but part of a long-term trend, and during a future economic expansion, we’ll have to significantly curtail lending because of a lack of liquidity. Many credit unions sell mortgage loans to manage liquidity and interest rate risk; yet, in most cases, mortgages are the most profitable loans in a credit union’s portfolio. They may also be the most insulated to credit risk, although the sand state credit unions would argue against that point until they’re blue in the face. Regardless, I believe selling mortgages won’t be enough to ensure credit unions remain able to lend.
How can we continue to grow our collective market share in lending? Many credit unions in the last five years have used loan participation agreements, selling up to 90 percent of a pool of loans to other credit unions. Yet the last year or so has exposed the limitations of that strategy—as arguably there are now more loan sellers than loan buyers, especially when it comes to auto loans.
The answer may come in the form of loan securitizations or perhaps whole loan portfolio sales to institutional investors. However, these options are likely only going to be available to larger (think $1 billion and above) credit unions that have enough volume to make a deal worthwhile for the investor. Unfortunately for smaller credit unions, I believe long-term liquidity issues will cause the pace of consolidation through mergers to increase.
Finally, I’ve only addressed the loan side of liquidity pressures. When I look at today’s millennials and even Generation X, I don’t foresee them parking money in credit unions at low rates like the silent generation and older baby boomers that are the source of the vast majority of our deposits today.
The bottom line is: I question whether any one source of funding will be sustainable. Depending on economic conditions, credit unions may choose to fund loans through deposits or sell a combination of loans if investor demand is strong. The level of financial acumen needed to manage liquidity in the future will increase far faster than our balance sheets.
Bill Vogeney is chief revenue officer and self-professed lending geek at $5.6 billion Ent Credit Union, Colorado Springs.