Why Deliberate Pricing and Efficiency Are Key for Future Lending


Today’s lending environment is unique, with rates rising faster than many of us have experienced in our careers and inflation at its highest level in 40 years. At the same time, longer-term trends such as automation and artificial intelligence are helping lenders use technology to make better credit decisions more efficiently. This particular moment in time presents both challenges and opportunities for credit union leaders and the members they serve.

A full throttle challenge

One of the common challenges we’ve seen since the start of COVID is institutions opening all their lending floodgates and waiting for production. For most of the past two years, liquidity has been high across the sector and consumer borrowing has declined. This has caused many credit unions to chase consumer loans, and therefore loan yields, to the bottom.

After the Fed began raising rates in March 2022, these low lending rates began to attract more consumer attention. With their lending restrictions fully open, some institutions quickly filled their balance sheets with loans below market rates. Lending volumes grew so rapidly and institutions were so hungry for loans that some executives may not even have acknowledged they were mispricing assets until after the fact. This creates a very difficult short-term dynamic, especially if the institution is required to sell these mispriced assets at a loss to generate cash.

Trends in mortgages, autos and unsecured loans

At the start of 2022, early mortgages were the first to be impacted when the long end of the yield curve took off and the market started to see signs of rising rates to come. Many institutions got stuck with mispriced first mortgages on their balance sheets at the start of the year and turned to variable rate home equity lines of credit as the mortgage refinance boom ended. HELOCs can benefit consumers because they don’t have to disrupt the very low rate on their first mortgage and can affordably access the equity needed to make improvements to their home. From a lender’s perspective, HELOCs are attractive because of their variable rates and the substantial amount of equity available due to several years of strong home value growth.

In the auto lending sector, we have seen large swings in risk-adjusted return on equity. Traditionally, ROE for automobiles was around 15% before COVID. During the pandemic, when there was a shortage, this percentage had dropped to 10-11%. Now that there is a shortage of cash, the ratio has moved the other way in a range of 16-18% to attract investors to the automotive space. The historically high volatility of interest rates has had a significant impact on automotive portfolios. For example, a loan at 1.99% in the old environment is now lower than a 2-year Treasury note at 3.00%. We believe auto rates need to go up to make sense on credit union balance sheets.

Unsecured consumer loans, including credit cards, are where we’ve seen the greatest impact from partnerships and fintech arrangements in recent years. Some models and algorithms have been better at predicting losses than others, but new concerns about potential defaults and charge-offs are leading lenders to watch unsecured portfolios more closely and put more emphasis on credit quality versus quantity of unsecured loans. As a type of “canary in the coal mine,” unsecured loans are often an early indicator of credit performance and have implications for other types of loans.

Changing expectations for the short and long term

In a normal environment, credit unions start planning for next year in the fall. While we expected this pattern to continue, we saw many plans for 2022 scrapped in March, April and May as lenders grappled with the rate shock. In the near term, addressing and internalizing the impact of rising rates on deposit collection efforts, portfolios and organic loan originations took center stage. However, as the third quarter draws to a close and we prepare for the fourth quarter, credit unions are refocusing on specific actions they can take now to better manage their income statements and budgets. As lenders seek to offset and mitigate some of the negative impacts of rising rates on their loan portfolios, we expect loan transactions to increase.

One of the longer-term trends we’re seeing is that credit unions are developing a scalable origin through new partners and platforms. Just as credit unions have adapted their auto lending business to interface with indirect networks and offer financing at auto dealerships, we are seeing the same kind of integration and adaptation with unsecured loans and HELOCs. through new technology platforms and fintech partnerships. We expect greater integration and coupling of high-performance user interfaces and APIs with credit union balance sheet knowledge and lending acumen to drive new efficiencies in loan origination.

A consistent and deliberate pricing strategy

We advise credit unions to have a consistent, deliberate and quantitative approach to loan pricing. Clearly understanding and tracking the economic value of what the institution is directly originating versus what it could access in the secondary market is critical and will inform our decisions as lenders and balance sheet managers.

Credit unions that choose to pass on above-market value to their members should do so consciously as a strategy to build loyalty or disrupt their market. An intentional approach to pricing can help leaders pivot quickly as rate environments change and avoid nasty surprises, like realizing too late that their co-op can’t sell loans because they’ve been granted. at below-market rates.

Not just an academic exercise

While performing rate hike shock analyzes may have seemed like an academic exercise in recent years, the current environment is a clear reminder of why these exercises are so vital from a safety and soundness perspective and for ensure our lending engine is ready for the future. As the future of lending continues to evolve, it will be essential to increase the efficiency of decision-making operations while managing risk appropriately.

An uncertain future

Relative values ​​are on the rise, but are they enough to bring loan buyers back into the fold? Economic uncertainty, along with internal demand for loans, quickly transformed the environment from a seller’s market to a buyer’s market. However, there comes a point in every bounce where participants consider the rewards to outweigh the risk. It remains to be seen how far we are or if we are close to it.

Travis Goodman
Kevin Shaner

Travis Goodman (left), Director and Kevin Shaner, Managing Director ALM First Financial Advisors Dallas

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