This article was written by Ian Lampl, CEO of LoanStreet, for the Credit Union Journal. The original article was published on July 3, 2019.
Loan participations provide credit unions opportunities to significantly increase income, achieve greater balance sheet diversification and improve their liquidity position. Yet, many credit unions have been hesitant to pursue them. Among the top reasons: marketplace myths that sadly discourage their use.
The truth is that technological innovation and legal standardization have made loan participations easier and more convenient than ever. Substantial automation of many parts of the process – from creating participation pools to monthly reporting – has created an environment in which sellers of loan participations can manage their entire balance sheet efficiently with loan participations. Standardization has reduced the complexity of completing the sale and managing ongoing compliance
That’s why it is critical to have the latest knowledge when determining whether or not loan participations are right for your credit union. Here are some common myths and the facts to debunk them.
Myth 1: Funding new loan growth starts with issuing CDs and taking non-member deposits.
Yes, it’s certainly true that issuing CDs and raising non-member deposits can bring in new funding; however, the costs associated with those liquidity tools are real and often suboptimal compared to selling loan participations.
First, gathering deposits through expensive CD sales raises a credit union’s costs, reducing net interest margin. Second, this does nothing to stem concentration risks. If anything, typically, the outcome is to make asset concentrations even worse once a credit union continues to lend on the back of the new deposits. And, issuing CDs or raising non-member deposits reduces capacity to do so in the future.
With loan participations, a credit union reduces concentration risk, increases income, increases return on equity by increasing balance sheet velocity (or turnover), and increases access to future liquidity the more it is used. In short, funding new loan growth with loan participation is a long-term sustainable strategy.
Myth 2: Loan participations are an administrative headache, especially when there are multiple buyers.
Historically, loan participations have been daunting. A credit union would have to put together a pool for sale (or decide which commercial loans to sell), have a sense of fair market pricing, and be on the hook for knowing or finding the likely buyers. And, this didn’t even include the effort or needed expertise to run the monthly reporting which lasts for several years to each buyer. For many credit unions, it probably didn’t make sense to devote a significant amount of internal resources to manage these efforts.
Today, it’s possible for credit unions to efficiently find buyers thanks to new technology solutions offering online networks, as well as widely-adopted standard agreements that materially reduce the administrative burdens associated with completing a sale.
Powerful new tools can automate the ongoing financial and regulatory reporting, making the monthly process of distributing information and money to purchasers easier than ever. Together, completing a sale and running monthly financial and regulatory reporting no longer requires any meaningful internal expertise; just leverage existing technologies like any other part of your credit union’s day-to-day functions.
Myth 3: Loan participation sales cut into interest income and can damage a credit union’s relationship with its members.
There should be no real reduction in interest income and no impact on your relationship with your members. While selling loans can reduce interest income momentarily, a selling credit union gains noninterest income from servicing income each month and premiums at the time of sale.
A selling credit union will more than likely continue to generate new loans and replenish its balance sheet with new interest earning loans. In the end, the selling credit union will likely have the same dollar amount of loans, a higher loan count (meaning more diversification and less risk), the same interest income as well as new sources of noninterest income in the form of premiums and servicing income. Quite a powerful outcome for a transaction that also increased liquidity.
And when it comes to impacting member relationships, there will be absolutely no change. In almost all cases, members never even know that a transaction occurred since your credit union will continue to service the loan.
Myth 4: Credit unions should only engage in loan participation sales when they need liquidity.
Selling loans is a balance sheet management exercise regardless of liquidity needs. By selling what you naturally generate and buying what you don’t, a credit union can manage its entire balance sheet rather than waiting until a liquidity crunch to sell loans. Simply put, loan sales and purchases are powerful tools to be used at all times.
The conventional wisdom is to wait to sell until liquidity is tight. This frequently results in credit unions selling loans when liquidity is at its lowest across the industry – and at sharply reduced prices. That’s because there will likely be enormous pressure just to get the deal done and the sale is occurring in a market when everyone wants to sell and no one wants to buy. It’s the loan market’s version of buying high and selling low.
Instead, many credit unions would do well to recognize that there is seasonality to industry liquidity. Selling when most credit unions are liquid can create more demand, better execution, and increased premiums for the same pool of loans.
Myth 5: Our credit union’s core system won’t allow me to sell loan participations.
Yes, many core systems have terrible support for loan participations. The participation or investor modules they offer are often manual and inaccurate. The myth is that you need your core to support participations. Simply put, there is no need to rely on your core to support your participation program.
Today, there are technology providers that can automate participation reporting without need for core support or integration. Stop waiting, relying upon, or working with a terrible participation module. There are simply better tools available that your credit union can leverage.
Ian Lampl is Co-Founder & CEO for LoanStreet Inc. He can be reached at email@example.com.