Five short-term questions to answer in between your planning sessions for the long-term future
As I write this, it’s been about two months since the sports world seemingly set the precedent for the U.S. economy by shutting down operations, setting the stage for an episode that has been a blur for virtually everyone. As essential businesses, credit unions and banks have been right in the middle of all of the activity.
People wanted cash. They needed emergency loans. They needed payment deferments and modifications. In a matter of 72 hours, I realized the economic impact of COVID-19 was not going to be anything like the financial crisis and the Great Recession. This was much more severe and faster than 2008-2009; anything we thought we could leverage from that time period was pretty much worthless.
Where are we headed? I think today’s economic and social realities make long-range planning a difficult thing to do. Certainly lenders and senior management teams have to be evaluating segments of the economy that will suffer from displacement and disruption in the long run. Yet there is so much to do in the short term that you need to take turns thinking and planning long term while acting and executing short term. So what are the short-term decisions impacting credit union lending?
1. How long will you continue to make emergency loans?
Many credit unions, either through planning for past government shutdowns, or from a response to a natural disaster affecting their operating area, have developed emergency loan programs that helped members at the start of this pandemic. Some chose to utilize normal underwriting guidelines; some, like Ent, have only basic requirements that lean heavily on the member’s account relationship and not FICO score or ability to repay. At some point, credit unions have to decide when the emergency need is over, and when to resume to more normal underwriting. That tipping point has a lot to do with how your area is restarting, how many businesses are re-opened and, to a certain extent, whether your members are adversely effected by the pandemic.
2. How do your members transition from emergency to recovery?
It’s pretty clear that the economy under COVID-19 does not have an on-off switch. It’s more like a dimmer switch, and many members will continue to need assistance after our first attempt to help them. Can members pay back their emergency loans? If not, how do you get them to pay partial payments? What kind of loan modification programs can you utilize? At this stage of pandemic recovery, I think the lessons learned from the Great Recession become a little more applicable. In mid-March, members didn’t want payment modifications, they wanted no payments. By mid-June, you need to figure out how those most impacted by the economic issues of COVID-19 can resume some reasonable payment amount.
3. What holes in your underwriting do you need to plug?
There’s not a credit union that hasn’t relaxed its lending standards in the last five or six years to drive more business. The question is, how much have you relaxed your standards and where have those changes exposed undue risk? As an example, if you’ve relaxed standards and have dramatically increased sub-prime lending, it’s likely that this group of consumers will be adversely affected by the economic displacement and disruption. If you’ve dramatically increased used car lending, your losses may skyrocket as well due to the trickle down impacts of the pandemic:
- More people working from home and not needing a vehicle
- Service, hospitality and tourism employees more likely to have a used car loan and be out of work
- A glut of used cars resulting from lease returns and limited sales
- Falling values resulting from huge financial incentives on new cars—that itself a trickle-down impact of the COVID-19 economy
4. When to make tough decisions?
It’s likely some borrowers will not financially recover in time and you’ll need to make tough decisions when to recover the collateral and charge-off their loan. Since I personally looked at so many member scenarios through the Great Recession, I consider this decision process a bit like triage, done based on the answers to questions like these:
- What can the member pay now? Is it some acceptable amount, at least covering the interest due?
- How long does it appear their situation will continue; is this long term or short term?
- Are you potentially increasing the risk for loss by dragging out the payments? On an unsecured loan, you have no collateral that can be sold so you have nothing to lose. On the other hand, the value of a car may be declining faster that the balance of the loan with reduced payments.
- Was this a strong borrower to begin with? Perhaps the borrower had marginal credit and ability to repay when you made the loan. COVID-19 certainly hasn’t helped. Ultimately, you have to make the determination of whether the loan and member relationship has a reasonable chance of being salvaged.
5. How to forecast the allowance for loan losses?
I have 19 years of loan loss numbers here at Ent at my disposal. I know how a recession impacts losses by credit tier and loan product. But none of us have experienced a scenario like this. To do your forecasts, it might be helpful for your credit union to compare how your portfolio and economic conditions compare to 2008-2010. On the plus side, I believe that residential real estate loans will not generate significant issues like 2008-2012. Back then, we had a glut of homes on the market and artificial demand courtesy of pick-a-payment loans and subprime lending that have not re-emerged. We also had a lot of consumers that obtained 100-120% LTV home equity loans prior to the Great Recession. Thankfully, we have not revisited those loan parameters either. On the other hand, I think auto loans could incur a bigger increase in losses than we experienced over a decade ago. I think the work from home initiatives and the technological changes in vehicles that are occurring (such as electric versus the traditional internal combustion engine) leave us in a position that auto loans could have the greatest negative impact to earnings and losses on our balance sheet.
Act short-term, think long term
As I alluded to earlier, I think that we should avoid getting too obsessed with either being reactive to our short-term problems or speculating in the long-term ramifications. A balanced approach is needed to serve our members in the short term yet ensure that credit unions are well-run and in position to be a steady, consistent provider of financial services in the marketplace through the current challenges and beyond.
CUES member Bill Vogeney is the self-professed lending geek and chief revenue officer for $6.5 billion Ent Credit Union, Colorado Springs.