This Expert Opinion article was written by Ian Lampl, CEO of LoanStreet, for Credit Union Times. The original article was published on March 8, 2019.
Tough question: When was the last time you performed a serious review of your loan participation reports?
Don’t worry, you are not alone. Most credit unions LoanStreet surveyed, regardless of size, admit they rarely do. For example, what if you purchased an auto loan pool expecting a 3.5% yield but due to inaccurate monthly reporting, you received only 3.25%. Would you still have purchased the pool? Probably not.
On the other hand, what if you sold a pool expecting to retain 25 basis points of servicing income, but due to inaccurate monthly reporting, you only earned 15 basis points. Would you still have sold the pool? Again, probably not.
Accurately tracking and reporting data is critical to ensuring that your credit union receives every dollar it earns. Although you can trust your participation partner, always verify: Monthly reporting is prone to material mistakes due to flawed core modules as well as human error.
The participation reports LoanStreet has audited, from the very largest credit unions to the smallest, do not accurately report the correct proceeds to the purchasing credit union. In many cases, the lead or selling credit union is losing roughly five basis points or more per year in servicing income and, in other cases, the purchasing credit union can easily lose 2.5% to 5% of their return per year.
In fact, inaccurate reporting is so prevalent in the industry that regulators are starting to get more involved. Traditionally, regulators focused on the up front due diligence part of a loan sale. But last year, the NCUA’s Office of General Counsel issued a new opinion on loan participations – its first opinion on loan participations in years – that highlighted the need for credit unions to comply with the loan participation regulation over the entire life of the transaction, not just at the time of a sale.
The fact that regulators are turning their attention to compliance over the life of the loan is not surprising. After all, the failure to accurately report monthly proceeds typically also results in a breach of regulatory requirements as well. But it can also be a compelling financial issue since even small errors can add up quickly.
Some of the most common ones that LoanStreet encounters are the improper calculation of servicing spreads or incorrect deductions for charged-off loans. Other inaccuracies occur so routinely they often go unnoticed. For example, it is surprisingly easy for sellers to unknowingly take money from one loan to fund the costs associated with another loan in the same pool. Or, to not properly track the increases in principal and over-distribute funds.
Take, for instance, the accounting of so-called skip-a-pay programs. If you have a skip-a-pay program that increases the principal balance of the loan to the member instead of charging that member a cash fee, the purchasing credit union should receive the benefit of that principal increase without offset from that loan or any other. The trouble is that many of the back-office systems and modules that selling credit unions use to manage their loan participation program often automatically deduct the principal increase due to the skip-a-pay program from other loans in the pool, or otherwise charge the purchaser for that principal increase. Even though the numbers appear to add up in monthly reports, they are nonetheless entirely wrong.
The differences in return caused by these mistakes can materially impact everyone’s return. What’s more, these errors compound over time and ultimately reduce the yield to the purchaser or the servicing income to the seller in meaningful ways.
So, what can you do? First, make sure your credit union is reviewing your monthly reports and asking the right questions. Was the actual interest received on each individual loan equal to the agreed-to pass-through interest rate applied at the loan level, as opposed to a result of simply doing pool-level math? For loans with principal balances that increased, ask how that principal balance increase was tracked, or if the increasing balance was improperly deducted from other loans’ principal payments. Second, and perhaps more importantly, you should consider whether the technology systems you have in place ensure that these errors will not happen in the future. Simply put, manually checking these reports each month is an error-ridden proposition and utterly unscalable. The only path forward is to have technology systems in place that properly calculate and track these items.
Ensuring your credit union earns the returns it deserves comes down to putting the right systems, safeguards and processes in place. It requires the attention of senior management and potentially some additional technology resources, too. But it’s an investment that your regulators, board and members should be happy you made. After all, it presents the opportunity to not just strengthen your compliance practices, but meaningfully bolster your bottom line.
Ian Lampl is Co-Founder & CEO for LoanStreet Inc. He can be reached at email@example.com.