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Mar 29 2016

A Mortgage for Your Car?

Feature

Written by webmaster

3 min read

By Cynthia R. Walker, CEO

At the time of the Great Depression, most home mortgages were short-term. The common term was three to five years, with no amortization, interest-only payments with a balloon at the maturity. Loan-to-value ratios were also below sixty percent. These terms contributed to the high rate of default during the Depression. Since that time, the mortgage industry has evolved and changed through regulation, industry, and consumer influence to modify loan terms, rates, and payment structures, thereby increasing the number of people who could afford a down payment and monthly debt service on a home.

According to the Census Bureau, in 1940, the median home value adjusted for inflation was $30,600. Now, as the average amount financed for a new auto is very close to $30,000, 84-month loan terms are becoming more common. As we know, people shop for vehicles largely based on the monthly price. Therefore, pressure mounts to increase the terms to keep the monthly payment in an affordable range. According to the OCC Semi-annual Risk Perspective published in the fall of 2015, banks are easing underwriting standards and terms, particularly in auto lending to remain competitive.

Experian’s State of the Automotive Finance Market for the Fourth Quarter of 2015 reports the average length of new and used auto loans is 67 and 63 months, respectively. The percentage of new vehicle loans with terms of 73 to 84 months grew by 12% in Q4, reaching nearly 30% of originated new vehicle loans. Similarly, the percentage of used vehicle loans with comparable terms grew by 10.8%, and represents over 16% of used vehicle loans. With the extension of loan maturities and higher loan-to-value levels, there will be increased risk in loan losses due to loan balances exceeding collateral values for a longer period of time. Another risk that should be considered in this trend is the potential for an increase in interest rate risk.

With new and used auto loans in the credit union industry up by 16% and 12.7% during the last year, it may be time for credit union management and the ALCO to evaluate lending practices, trends, and assumptions used in the interest rate risk analysis.

We recommend you consider some of the following items:

How has the credit union’s loan portfolio and loan mix changed in the last year or two?
Are we making longer-term automobile loans?
Are the auto loans with the longer terms starting to represent a material percentage of the credit union’s assets?
Should these loans be identified into their own loan category to better understand the credit union’s exposure to both interest rate risk and loan losses?
Are the longer-term loans priced to compensate for increased risk?
Are there other reasons to identify and model these longer-term auto loans separately?
Has the credit union’s overall loan turnover lengthened in the last couple of years?
Have the assumptions been reviewed and adjusted in the IRR analysis to reflect this trend?
Has the net interest margin improved with the increase in auto loans?
Does the increase in net interest margin offset some of the potential risks?

These are a few items to consider and discuss with the ALCO and document in the ALCO meeting minutes. Mortgage loans and long-term investments have been highly scrutinized as a source of interest rate risk. As the consumer auto loan terms extend, this could also become a source of risk on several fronts that should not be ignored. The best approach is to identify the longer-term auto loans and make sure the potential interest rate risk is measured, managed, and monitored.

In today’s environment of diminished net interest margins, with many analysts expecting they will continue to compress, structuring the balance sheet for earnings in 2016 is imperative. The longer-term auto loans may be an acceptable strategy as long as these loans are priced appropriately for the inherent risks. Loan, investment, and funding mix should focus on actively managing and achieving any and all incremental increases in net interest margin. While we spend a great deal of time anticipating the impact of hypothetical interest rate increases and structuring our balance sheets to reduce potential IRR, credit union’s should focus on maximizing their net interest margin in any rate scenario. The proverbial trick of balancing risk and return still applies.

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Jan 14 2021

Five Top Credit Union Topics For 2021

As we move into 2021, the following topics might be worth discussing and considering with your management team.

Earnings

During the first half of 2020, net interest margins came under substantial pressure as market interest rates were shocked dramatically downward. Net interest margins are expected to remain under downward pressure throughout 2021 as investment portfolios continue to reprice lower and share growth continues.

One of the easiest and quickest responses to declining interest income is to address the cost of funds. Many credit unions still have room to decrease their cost of funds, as shown in the September 2020 ending period graph below.

Source: NCUA

Delinquency

Based on the September 2020 call report data, loan delinquencies and net charge-offs remained low and were below September 2019 delinquencies. Loan forbearance and other assistance programs in place through the entirety of 2020 may have helped delinquencies. Also, certain sectors of the economy are not as impacted as others. The unemployment rate is expected to continue drifting lower in 2021. However, as the assistance programs are lifted, delinquencies and charge-offs are expected to increase as unemployment remains substantially above the years leading up to the pandemic.

Source: MHSI Online Peer Analysis Module through September 2020

Credit Union Philosophy

Serving the underserved has always been a hallmark of credit unions, and now more than ever, there is an opportunity to do this for many credit union members. As these times have been challenging, credit unions can continue to evaluate and prioritize how to best serve members in the coming year, especially those under financial stress. Exploring how to provide service to those that are underbanked might be an opportunity. One option may include evaluating risk-based lending policies and programs, especially given the robust liquidity on most credit union balance sheets. New and alternative avenues to bolster income should continue to be explored.

Digital and Technology

As the pandemic shifts and prolongs, credit unions should evaluate if their electronic delivery channels meet members and potential members’ needs. Moving to or improving digital delivery channels should be accelerated and prioritized. Digital delivery should include evaluating loan origination and servicing channels to maximize new loan volumes. Online and remote financial services will continue to grow and may be the preferred way members access and manage their financial activities.

Balance Sheet Growth

Before the pandemic, many experts anticipated credit union loan growth to taper off but remain positive. After the first quarter of 2021, loan production became unpredictable, however, by the end of the third quarter, annualized loan growth was 6.34%. Real estate lending, driven by the abruptly lower interest rate environment, helped with the growth. Experts anticipate loan growth to be around 6.0% to 6.5% over the next 12 months as the economy recovers.

The first few months of 2021 may see strong share growth as the second round of government assistance and stimulus takes hold, and households remain reluctant to spend until signs of COVID easing and warmer weather occur. Share growth last year increased at an annualized rate of over 18% and is expected to be approximately 8.0% to 10.0% in the coming year. If double-digit growth continues, earnings sufficient enough to sustain capital will be critical. If economic conditions improve and overall consumer activity increases, loan growth and increasing long-term interest rates could counter some of the anticipated income pressures. Fortunately, the credit union industry is very well capitalized and able to ride out the adverse conditions and absorb some more growth, even if earnings are reduced.

Nov 04 2020

The Bottom of the Frog Market

Several years back, I went to Mexico for a vacation. While there, I found a ceramic hand-painted frog-shaped planter that I wanted. My husband loves the hunt, and his quest began. Every time we saw a frog-planter, he would start negotiating with the vendor to get the lowest possible price. We searched for several days and would stop in different towns and check the markets while enjoying our vacation and exploring. When we found a frog, he would inquire about the price and negotiate for further discounts. After a few days and no success at getting the cost of the frog below a certain point, my husband declared, “we have hit the bottom of the frog market.”

…

The Bottom of the Frog MarketRead More »

Sep 30 2020

Economic Uncertainties and Interest Rate Certainties – Asset Allocation Assessments and Considerations

Future GDP Projections

In September, the Federal Reserve Chairman spoke publicly on several occasions and reiterated that the central bank is committed to helping the economy “for as long as it takes.” He noted continued improvements in the economy, but also acknowledged a highly uncertain path ahead. The September FOMC (Federal Open Market Committee) projections are now projecting a full-year GDP decline of 3.7%. This is substantially better than their previous expectation of a 6.5% decline. However, they lowered their 2021 outlook from 5.0% to 4.0% and their 2022 outlook from 3.5% to 3.0%. Their 2023 outlook is at 2.50%.

Interest Rates and Economic Uncertainties

The FOMC also indicated that they would allow inflation to run above 2.0% on a sustained basis before any federal funds rate increases. As such, most individual members of the Committee indicated that the federal funds rate could remain close to zero through 2023. Some economists and analysts even think that we may not see an increase in the federal funds rate until 2024 or 2025. They believe that it will take up to five years for the global economy to fully recover to pre-pandemic levels.

The risks to the FOMC economic growth projections are high. Even the Chairman of the FOMC acknowledged the economic uncertainty of the path ahead. Following the sharp rebound in many economic data measures and drop in the unemployment rate, some recent measures have disappointed compared to expectations and some are indicating a recovery that is stalling. At the current time of this article, the nature of further fiscal stimulus continues to be negotiated in congress and some are not expecting a resolution until after the presidential election. Of course this only adds to the current economic uncertainty.

What is highly certain over the short to medium term timeframe is that interest rates will not likely be increasing more than just relatively minor fluctuations in the medium to long end of the U.S. Treasury yield curve. It is more likely that potential risks on the horizon could drive medium and longer-term U.S. Treasury yields even lower.

Reassessing Balance Sheet Strategy

Given the above outlook, it would certainly seem that some credit union balance sheet strategies of recent years should be reevaluated for the foreseeable future. Reassessing asset allocation strategies is possibly more relevant at the current time than at any time in the past several years. For example, the credit union may want to ask itself how much should we be redeploying assets into two to three year investment CDs given current interest rates on those maturities. If the answer is less than previous years, then what are the alternatives we can explore.

Priorities Going Forward

In exploring alternatives, the first priority for credit unions is of course serving members. Assessments and considerations could include expanding the types of loans offered, reevaluating risk based lending allocations, increasing real estate concentrations, debt consolidation programs, and loan payment support alternatives to name just a few. Secondary to the first priority are considerations such as allocations to loan participations and alternative investments. For example, should the credit union assess CUSO or similar investment possibilities. What are all of the possibilities for these type of investments that may be available to the credit union? After all, an alternative of earning five basis points at the corporate credit union with too much of assets is not likely to accomplish any priorities or goals for the credit union.

The present time and foreseeable future is a great time for credit unions to really show how they can serve and support members during these challenging times. Being there for your members is for sure the highest purpose for the credit union and always assessing ways to provide service and assistance to them will always be the credit union’s first priority. In addition and secondarily, now more than any time in recent years it may make sense to really take a deep dive into the above asset allocation assessments, considerations, and possibilities. Ideally, the best answers going forward would combine the first priority with the second to optimize balance sheet performance while best serving members.