Competing for Funds in a Rising Rate Era

[00:00:00] Vince: Welcome everyone to 22 minutes in lending. I’m your host, Vince Passione. And I’m really looking forward to our next guest, Alabama credit union, chief lending officer, Benson Bowling. Benson’s an Alabama native and he’s been in the credit union industry for 34 years, ACU. I’m looking forward to our conversation. So without further delay, let’s start these 22 minutes in lending.

[00:01:00] Benson, welcome. And thanks for coming on the podcast.

[00:01:02] Benson: Thanks, man. It’s fun to be here.

[00:01:04]Vince: So Benson, why don’t you give us a little background on the credit union? About two years ago, I had a chance to sit with your CEO when he was telling us about this acquisitions into the bank. Obviously you’ve been pretty acquisitive and growth is a big part of the key strategy at ACU.

[00:01:17]Benson: It is. We’ve been around for 60 years or so. I have to check the calendar to make sure I’ve got that right, but it’s in that neighborhood. We began as the University of Alabama Employees Credit Union, and we’ve expanded to multiple different segs over the years, including some large manufacturing.Outfits include Mercedes Benz, Pfeiffer Wire, which is an international wire company, and Airbus and also and quite a few others in addition to the University of Alabama.

[00:01:41]Benson: And we’ve added community charters across the state as well. And we have a charity that feeds hungry children with secret meals for hungry children. And those who join the association for that are also eligible for membership.

[00:01:54]Benson: So we’ve got a pretty broad footprint.Our growth has come over the last two years from segments of our  low information legal primary.

[00:02:02Benson: I’m talking about the lending growth. That would be our commercial real estate, which is 90 percent of our commercial portfolio in our automobile portfolio, which is primarily driven. The growth is driven by our indirect operation.

[00:02:14] Vince: So let’s go back to the portfolio. So about 1. 3 billion,it looks like looking at your June 5, 300 report let’s start on the autoside. So on the auto side,it looks like growth is in the indirect side. You’ve got a pretty large direct portfolio. We take a look on the auto side. Average price a new auto is about 46, 000.Average price of a use is about 26. Interest rates now and payments are up.

[00:02:38] Vince: Average payment on that new auto, I think is about seven 50.First off. How do you feel about the consumer right now, dealing with those kinds of payments and also term is up.

[00:02:46]Benson: Well, it’s really kind of a scary time for consumers, and we’ve watched the average price go up and. You always think you’re going to get to a place where it’ll sort of top out. And sadly, we’ve seen it continue to grow. It’s not that uncommon to see fairly conventional pickup truck committed to price tag 75, 000, which really, for those of us who’ve been doing lending for very long, that sort of staggers the imagination.

[00:03:10]Benson: And the rates impact that monthly payment as much as the average price of the vehicles do. So for consumers right now, it’s extremely difficult.

[00:03:17]Benson: And I think it is contributing to some factors that bring some real uncertainty into the auto lending. landscape

[00:03:23] Vince: Now, you’re, you said growth for you what percentage of the portfolio is direct versus indirect?

[00:03:28]Benson:  present time indirect accounts for probably 75 to 80 percent depending on and directives.

[00:03:33] Vince: Got it. And on the LTV side, are you concerned? I mean, I look, and I was a dealer track for many years and we had a leasing business and residual values are pretty tough, right? When you see values start to collapse in the industry, these prices are pretty high.

[00:03:54]Vince: You concerned about the pricing and are you concerned about what might happen on residuals in the future?

[00:03:56] Benson: I am a little concerned about that. I do think we will see some pullback of values of all those that will be substantial over the course of the next year or 18 months. And there’s no doubt. It’ll impact losses on our. Repossessions and those types of things we’re already beginning to see people who are doing voluntary surrenders on vehicles that are much higher than usual pace and. I think it’s driven by the fact that they’re so upside down in your vehicle’s value. It’s not uncommon for us to have someone pull up an automobile outside one of our branches and park it, and they’re not even paying us to do them a loan.

[00:04:25] Benson: I think it’s just a frustration with the valuation or perhaps getting ready to trade and looking at what they’re up against in the trade, you know, value. So, we’re dealing with that today and I think we’ll see a little more of it. So for the industry, there’s no doubt we’re going to see losses increased a little bit as those residual values begin to drop.

[00:04:44] Benson: We don’t do leases in our portfolio. So we’re not as exposed on that part of it. And the leases live and die by the residual values, you know, so we do traditional lending and to the extent we have exposure there because the term got a little longer, but we’ve seen 96 months terms and that type thing, we have not gone to those terms internally. Our longest term is 84. I guess the biggest change we’ve seen is more people opting for the 84 month term over 72.

[00:05:08] Vince: No, look, they’re trying to make a payment work and that’s been the big challenge and negative equity becomes a real challenge, right? When they start going in for trades, that’s going to be a problem over time. Let’s move over to small business lending. So you’ve got a pretty large portfolio. It’s almost 300 million, I think, based on the call report. So first let’s start off with, is there a specific segment that you go after on the small business side?

[00:05:30] Benson: Well, commercial real estate makes up most of that, and we have a blend of what you might expect. In fact, if you count the loans, which are member business loans, but not classified as commercial according to regulation, we’re actually just over 400 million now. So it’s a substantial part of our portfolio.

[00:05:47] Benson: But a lot of that is rental home. I’m 25 percent of that are just for real. We have a substantial portfolio of multifamily apartment buildings, that type thing. We have some owner occupied commercial, some non owner occupied. There’s a mix of those in there. And we do some construction development, although it’s relatively small part of our overall operation. Commercial real estate is 90 percent plus of that. We do equipment and the things you might expect fleet vehicles, those type things. But, 90 to 93% of that portfolio is gonna be commercial real estate at any given time.

[00:06:21]Vince: Now, lots of discussion about commercial real estate. We were chatting before the call about it, right? This whole move to, you know, people are working from home. People aren’t going to malls anymore.

[00:06:21]Vince: How do you feel as you think about how you manage all this? How do you deal with a portfolio like that? When you look at what’s happening, commercial real estate, and we were chatting also at some point, right? There’s this big refi cliff that’s going to happen. It’s probably within the next year or two.

[00:06:46]Benson: So we have always maintained concentration limits on various loan types in our commercial portfolio. And over the past five years, we’ve tried to keep an eye on the trends and those trends have been away from, well at least can some uncertainty on the on retail place. So if you’ve got a traditional shopping center or mall, that’s going to be repurposed in a lot of cases to something entirely different, or the building, the structure there is going to be used for maybe service industries as opposed to what it had been prior.

[00:07:17]Benson: That can have some uncertainty on the long term valuation of those. Now, if you’ve got outstanding air doors and very good location, that’s going to have high traffic, odds are very good that you’ll be okay in terms of your value, but we’ve tried to limit our exposure in the retail space. And we’ve never done very much in the. Particularly the metropolitan large office complexes that are being affected by that. I do think that’s going to have an impact on the industry. Fortunately, in our portfolio, we have very little of that type property. So I think for Alabama Credit Union, we’re wearing good shape, but I do think you’ve got to manage for all grades.

[00:07:49]Benson: You got to keep a close eye on your concentration risk policy. And make sure that those limits are set where they should be. And then just try to manage from there. You want to serve your members and we’ve got a large group of commercial members that we’ve built relationship with over the last 20 years that we’ve been making commercial loan. And so when they come to you for their financing needs, you want to try to meet those and trying to balance between the needs of the member and those concentration risks. It’s just a delicate balance sometimes, but you really have to focus on.

[00:08:19]Vince: So let’s move to the mortgage side of the business. So I noted, you’ve got pretty large mortgage portfolio here. First off, how is demand going these days? And from a funding perspective, when you think of what’s happening to this consumer, right? I mean, 30 year mortgages are at 8%. Now for me, my first mortgage is at 12%, but that was back in the eighties.

[00:08:38]Benson: Right. So there’s a lot of moving parts in the mortgage world right now. Demand for new mortgages that we have is probably 80 plus percent home equity lines of credit. And that’s because everyone’s holding on to those 2. 9 and 3. 25 percent mortgages. They got with race for as low as it were for the long having the right floors, as low as they were for that extended period of  time, you know, people had their loans and they became accustomed to be able to refinance and.

[00:09:06]Benson: Take money out at a very inexpensive rate and bail credit cards and those types of things. Well, all that’s gone today instead. People are holding on to those mortgages, making their minimal payments. A lot of cases. So, we’re being impacted from both sides. We see the demand moving to. We also see the roll off that we get accustomed to every month.

[00:09:24]Benson: Limited to those minimum payments for the most part mortgages as people hold on to those. And I think we work through part of the difficulties that all the financial institutions are facing. As of today’s date, I guess, and I would look out over the course of the next year, and I think that will begin to get a little better. Things change, people need to move, they need to upsize or downsize or move to a new town for career changes. So, at some point, we’re not going to see people holding on those loans forever.

[00:09:49]Benson: But, right now, we are working those home equity lines and credit applications as they come in and meeting people’s needs that way. But it’s challenge, in particular for the consumer. Who is considering that move that they [00:10:00] really make, because if you have to sell your house and maybe you make a nice premium on it in terms of capital gains over the time you’ve been there. But you’re looking to move into a 7 percent loan when the past you’ve had a 3%, that’s a huge impact on how much house you can then buy and with the property values elevated, it’s kind of a double whammy for some people who are really needing to make a move right now. And I think that’s causing some one other way that consumers are seeing some pain in this market.

[00:10:28] Vince: No, it’s interesting. We moved very heavily into home improvement lending, but on the unsecured side, and we debate constantly internally. How much of that is, is being driven by just what you went through, right? Consumers own a mortgage that’s where they believe they own a mortgage, not a home now. That and stay at home, right? People are expanding their homes.

[00:10:50] Vince: But we always debate why someone would take a variable rate HELOC versus a fixed rate, you know, unsecured type product. But that explains some of it, right? The consumer is sitting there and saying, as you said, the trade off is I can sell the home, right? Well, I can’t bar against it the way I would like to. Now you hold these mortgages from a funding perspective, which is unusual, right? Many of our credit unions will sit there and sell these because of the fixed interest rate risk.

[00:11:52] Benson: Well, and traditionally we have all of our loans in our portfolio, but up until three or four years ago, we really didn’t do a lot of. Extended fixed rate loans 20 years with probably the longest term that we had up until about four years ago. As we look through our ALM modeling back then, we were able some 30 year fixed lending and we sort of put a cap on it to make sure we didn’t go too far with that. And we portfolioed those loans. We didn’t go very aggressive into that segment of the lending spectrum. We have partners, members who come in and say, I absolutely need a 30 year fixed and maybe we’ve reached our concentration limit or back in the years when we didn’t do those at all.

[00:12:16] Benson: We have referral partners that we’re able to send them to and so we maintain the relationship. And so it’s a win for everyone, and we have in the advent of the right hikes. We’ve seen over the last 18 months. We have discontinued the 30 year product here as well. So, right now, the longest term that we would do on a fixed loan is 20.

[00:12:33] Benson: But because rates are where they are on those, we have for the limited number of people who are making requests for purchase money and we see those folks electing maybe a 7 1 arm or a 5 1 arm. So you get a little lower rate and then I think everybody is sort of. Betting on the hope that during that 5 or 7 years fixed rate, that there will be an opportunity for rates to drop and they refinance it to something that’s fixed at that time. And so that’s where we are, and really it’s a very small segment of what we’re, we just don’t have much demand for those purchase loans right now.

[00:13:04]Vince: And so, Benson, you talked about term and we’ve seen past SVB, everyone turning around and really getting concerned about staying short. But as interest rates now, we’ve had 11 of these rate hikes in 17 months.You know, Powell may do one more. And then after that, the question is, at what point do you see the horizon sort of showing up where the next thing is rates coming down and locking in some of the longterm fixed rates make some sense. I mean. You’ve lived through this. I certainly have. So where’s that tipping point where you go from staying short to saying, well, I need to put some longer term assets on the books and lock in on some of these high rates.

[00:13:43] Benson: Well, Vince, if I were a little better at making those types of prognostications, I would probably close your retirement. And as we discuss this, I hope that nobody will. Take anything I say and go make investment decisions in their bond portfolio or anything.

[00:13:56] But as I look out over the horizon, I do anticipate we can have one more. I would like to think that’s it for a while. And the fed in an election year, we’re coming up on 2024. It remains to be seen how aggressive they’ll be during election year. I think that traditionally they haven’t done quite as much on that. And I do think that they have been very aggressive up until now. They’ve increased rates very quickly and in quite a bit, I mean, in a traditional ALM model, and you normally try for up 300 or down 300 sort of approach to that.You don’t ever model for up 550 in an 18 month period. I mean, it’s just something a little unprecedented. So if we look at the end of the year, we begin to see things level all, and I guess the big question is how long did it remain level and when do we anticipate some type of drop and as you know, the bond market and.

[00:14:44] A lot of the economists were predicting that we would be approaching that. If you go back to January, so this year they thought that today in September well, September, October, we would begin to see these cuts. And that has not come to pass. And the economic data continues to give us a lot of uncertainty. We see some things that look like they are showing positive signs that things are slowing down and that the rate hikes are taking effect. And then we see others that seem to be very resilient in economy, which would lead you to believe that flat or pall period may be much longer.

[00:15:15] Personally, I think probably by Q2 of next year, we’re going to know a lot more than we know today. And I think cuts sometime next year are. Likely, I don’t know that we’re going to see large cuts if I were having to bet and I wouldn’t want to bet. But if I did, I would say that we may see some small cuts sometime starting in the summer of next year, and they’re going to be done very slowly. Because I think the economy is still going to continue to be a little stronger. And then perhaps the Fed is anticipated this one,

[00:15:45] Vince:  So, Benson, going back to my question, then, when that milestone occurs, do you see yourself and your peers starting to look at term and seeing a longer term being more beneficial? Because most of the creditors we talked to today. They’re very concerned about term. And obviously, if we look at the way the NCA exams are going these days, right? One of the things they’re looking at is term, right? And that NEV evaluation,

[00:16:08] Benson: You’ve got to be careful and make sure that you manage. How much you have in those long term assets. I do think that by Q1, Q2 of next year, particularly if we’ve had a period of pause, you’ll see people more willing to extend those terms out a little bit because the expectation will be that we’re not going to continue to see the increases we’ve seen.

[00:16:08] Benson: Yes, I think you’ll see those moderate and some more options come into the market. will still have everyone kind of keeping an eye on liquidity and that may present for us to deal with and that will weigh into it. I also think consumer Expectations will play a role as well, because back to my earlier point can’t see people hold on to their. 3. 0 or 3. 25 mortgage forever and life changes come around when the consumers perceive that perhaps things are leveling out and the rates are moving in the right direction. I think we’ll see more activity in the purchase money loans and those type [00:17:00] things which will open things up a little for everyone.

[00:17:02] Vince: not exactly. So let’s move to delinquencies and the concern around the state of the consumer. So everyone seems to be tightening up their credit boxes. There’s a concern that delinquency rates are going to start to increase. I was looking at your 5300 report. Yours are actually pretty low. So how are you managing this?

[00:17:20] Benson: I really can’t say we’ve done very much differently than we always have. We try to be very conscious of our underwriting policies and we’re fairly conservative in the way we do that and we try to. When we do take risks, we do it based on reliable factors and proven, you know, reliable for us over many years.

[00:17:40] Benson: The delinquency we’ve seen right now is actually 30, 40 basis points higher than we’re normally accustomed to. So I do think that we will all see some increase in delinquency over the next year. I don’t think that’s really something we’re going to have to debate a whole lot because the steps the Fed has taken, the inflation everyone has seen over the last year and a half, two years, the demands on people’s budgets, people having to rely on credit cards to maintain the lifestyle they’ve had, or even just to make ends meet, even if it’s not a lifestyle issue, just being able to put food on the table and take care of their expenses for, you know, kids, school supplies or whatever it might be you take that into consideration, taking into consideration what we’ve discussed about how your car loan is being affected.

[00:18:22] Benson: I mean, you could have a situation where your car dies, your engine dies, and you had a payment of 350 a month, and now you got to pay 700 a month. I mean, all these things factored in together are putting a lot of demands on everyone’s budget. And so I do think that delinquency is going to be something everyone got to keep a close eye on over the next year. And then you can do everything you can to mitigate that. Some of the factors that are going to impact us already in your portfolio. So these elevated LTVs on automobiles, that’s going to weigh in. I think, you know, we’ve seen some people pull up at the credit union, surrender a vehicle. That’s not even past due because, they don’t normally give an explanation, but what we expect that is due is because people feel like they’re uptight down in their car, or maybe the payment’s just, to a point where their budget can’t deal with it anymore. And so they, they bring it. I just, I think we’re going to see people struggling on these things, at least for the next year.

[00:19:14] Vince: So let’s go back to liquidity. So it’s interesting. I had a previous guest on. We were chatting about we’re now operating in a world of zero gravity. And the last 15 years, interest rates were pretty low, almost negative. And deposits just had the tendency of staying put. And then 45 billion of deposits flowed out of SBB in a matter of hours.

[00:19:31] Vince: And suddenly you see the consumers are moving money from institutions pretty rapidly, just shopping for rate. And I always look at these deposit betas, right? the last time we saw these rate increases around 14, 15, what happened was it took about three years, right? Before there’s a lag as credit unions and banks repriced their saving products to get close to the fed funds rate. But if you look at this time, it’s almost lockstep, right? That beta is tracking right alongside of it. How do you operate in this world now, right? How do you operate in a zero gravity world where consumers can move money so quickly? How do you keep those deposits?

[00:20:14]Benson: Well, I think everyone right now is having a beat on rate. That’s where the debate begins. And. The relationship aspect that credit unions have always relied on with our members that trust factor that’s there I like to think that has some impact. I know that we’ve got an awful lot of members who have stayed with Alabama credit union and perhaps it’s a little negotiation You know, hey, i’ve got a cd that’s out there for a while and I don’t want to pay the penalty But i’d like to move it into a new cd that you’re offering today And sometimes you have to say we’ll waive the penalty for you to keep the money here I think that’s fairly common practice, but that trust factor.

[00:20:47]Benson: I hope will be part of that. credit unions have adjusted very quickly this time around, and I also think we have a little less exposure than some of your banks, which may rely on a small group of very large depositors because if those folks begin to move money, that’s something that can show up immediately. And you’ve already alluded to that, but the typical credit, you know, I know it’s true of us, the vast majority of our deposits are under that. limit that are insured already. And we have supplemental insurance on hours that in addition national insurance,we don’t have quite as much exposure where that’s concerned. much bigger group of small depositors as opposed to a small group of very large sponsor. So I hope that gives us a little buffer against some of these factors as well.

[00:21:28] Vince: Yeah, it’s, we were looking at this recent announcement of plat and pinwheel and you’re a seg based credit union, correct? I mean, mostly university based. So I’m assuming that a lot of these deposits that come in, these are direct deposits from folks paychecks, correct? Correct.

[00:21:43]Benson: Well, okay, so we are credit union and we have a lot of very large SEG groups that we work very closely with, but we also hold a community charter and we also have a charitable organization that people who join that charity can be members of our credit union as well. So we really have a pretty broad spectrum there. And we do have an awful lot of folks who are exactly as you described, the checking account with the payroll deposit coming in. And that’s something we’re always trying to grow. And it does give us a buffer against some of these things. But we are just like everybody else. Part of our effort to grow our deposits has been strictly right. And we do have folks that will move away from us or to us because of that, that don’t necessarily fit into that same relationship.

[00:22:22] Vince: Yeah, it seems like it’s all about rate right now. And I think trust is an important factor as you covered. I think it is. And certainly that’s the trust that you have with your membership base and you’ve run a great organization. So listen, we’re going to leave it there, Benson. Thank you so much for the time today. Thanks to all of our listeners for tuning in and please subscribe to the podcast so you can listen to future episodes and we’ll see you all back here at the next 22 minutes in lending.

[00:22:45]Benson: Thanks, Vince.