By Christian Widhalm
Loan balances at credit unions have climbed to all-time highs over the past five years, as their loans outstanding have increased at more than twice the rate of deposits (66.8% vs. 32.6%). As a result, the industry’s collective loan-to-share ratio stood at a record 84.8% at the end of the third quarter of 2018, surpassing the previous high of 83.2% set in December 2008, just prior to the global financial crisis.
On the one hand, this trend represents a positive development: credit unions are fulfilling their mission by meeting the financial needs of their members, while also improving returns by growing their earning assets. On the other hand, they are taking on more risk in doing so. In particular, there are concerns about high credit concentrations, especially in the auto loan category. According to Federal Reserve reports, credit unions held nearly one-third of the nation’s auto loans in mid-2018, and the industry’s car loan exposure continued to rise in last year’s fourth quarter. Furthermore, the high loan-to-share ratios are symptomatic of potentially tight liquidity overall.
For credit unions that wish to continue to serve their members’ needs and enhance their earning potential, but are wary of concentration and liquidity risk, loan participation has offered a solution. Loan participations allow an originating lender to sell or share their interest in a loan with other like-minded lenders. Selling loan participations can enable a credit union to retain a slice of a profitable loan portfolio, while providing liquidity, diversifying the balance sheet, reducing concentrations, and improving risk management.
Historically, loan participations have been transacted through brokers – a process that is plagued by high costs and inefficiencies. The traditional broker-based model allows sellers to access only a limited number of buyers, which leads to sub-optimal pricing. Up-front transaction fees and time-consuming due diligence and closing procedures can drive up costs. Additionally, loan participation transactions and servicing are often done manually, using spreadsheets, which can create operational and regulatory risk.
Technology Offers a Better Way
Fortunately, the deficiencies of the legacy broker-based model can be solved through the use of a digital loan participation platform. Technology now allows for the creation of a digital, real-time marketplace that efficiently connects buyers and sellers, automatically giving all interested parties full transparency with respect to the loan participations available for purchase or sale. This can eliminate the friction and reduce the expense of formerly manual processes – transactions can be completed in minutes or hours rather than weeks. The participation platform also can incorporate robust data and analytics, including credit risk and financial statistics on the loan participations for sale, as well as advanced valuation tools.
One such platform, known as LendIQue, has been created by LendKey, a leading lending-as-a-service platform for credit unions and banks. LendIQue will enable sellers to load their entire loan portfolio history onto the platform, so buyers can review and select loans that meet their credit parameters. All types of loans can be accommodated on the platform. Significantly, once a transaction has been consummated, the platform can automate such functions as loan servicing, financial reporting, and accounting, which previously would have required costly and error-prone manual processing.
Serving Members, While Managing Risk
Managing liquidity and concentration risk, while optimizing portfolio performance, are areas of vital concern for credit unions of all sizes. With loan-to-share ratios at record levels, these concerns are magnified. Many credit unions are approaching lending caps and concentration risk levels that could require them to slow loan growth – to the detriment of borrowers and their own profitability. A digital loan participation platform may enable more credit unions to resolve these problems, providing an efficient and cost-effective way to meet members’ credit needs and manage balance sheets.
More credit unions are increasing their involvement in loan participations to improve their loan-to-share ratios, increase loan growth, diversify assets, mitigate geographical risk, and ramp up return on assets. The emergence of technology makes loan participations more accessible, faster, and cost-effective, allowing credit unions to reap the benefits for decades to come.