Lending Perspectives: Running on Empty (With Not Enough Deposits)

gas gauge empty
Bill Vogeney Photo
Chief Revenue Officer
Ent Credit Union

6 minutes

Like the famous Jackson Browne tune, credit unions may find their loan funding tank running on empty. Is this temporary or a problem with long-term consequences?

Over the last year or so, I’ve been making predictions around the office that may be a bit of a stretch. I qualify them by saying “I could be wrong; I’m wrong all of the time.” This is true, but I think I’m wrong more than most people because I opine on more topics than most. It’s sort of like Michael Jordan saying he missed all the shots he never took. I promise that’s the only time I’ll try to compare myself with Jordan.

When it comes to funding loans, I will say “I told you so.” In this column a little over three years ago, I questioned whether credit unions could consistently fund loans solely through deposits. The COVID surge of deposits notwithstanding, the experience of the last three years has only increased my concerns about deposits as a long-term source of funding. The growth in digital-only banks has introduced even more high-rate deposit options for consumers. The earlier article on this topic also expressed my concern for the next generation of retirees and their potential lack of propensity to park money in credit unions.

A short time after writing that article on funding loans, my credit union, Ent, broke through the 100% loan-to-share ratio for the first time. A short time after that, COVID-19 hit, and we were awash with deposits. Now, less than three years after the start of the pandemic, many credit unions are out of funds and subject to rapidly escalating borrowing costs or high costs to liquidate investments.

The Flood of Loans

2022 has been a record year for lending at Ent. While mortgage volume has declined dramatically from 2021, we’re still making more mortgage loans than we’re taking in with repayments, so that segment of the portfolio continues to increase.

The stars of our performance have been auto and home equity loans, with those portfolios growing at an annualized pace of 25% and 79% respectively, through Aug. 31. When it comes to auto loans, we started to benefit when rates increased at the beginning of the year, as higher rates dramatically increased the cost of 0% financing. The combination of higher financing costs and not enough new cars to sell effectively killed 0% paid for by the automakers.

Home equity has been amazing, primarily because we were prepared for higher rates and how that would impact home equity loan demand. We didn’t stop making HELOCs like several of the big banks, nor did we pull back volume in 2020 and 2021 to help process mortgage refinances with our available staff. 2022 has brought quite the opposite scenario; we were able to redeploy mortgage personnel this year to help the flood of equity loan applications. Overall, we’ve benefitted from our consistent approach to lending. There’s a catch though…

The Flood of Deposits Has Dried Up

Between stimulus funds, people saving money because they couldn’t travel and perhaps savings from many not having to drive to work because work was at home, deposits surged in 2020 and 2021. Ent ended 2019 with $5.173 billion in deposits and a loan-to-share ratio of 94.11% after executing a large loan sale in Q4.

As of the end of 2021, we had grown deposits to $7.551 billion and the loan-to-share ratio had declined to 88.06%; that number was only that high because we had purchased several loan participations to help deploy our excess deposits. Overall deposits grew 23.1% in 2020 and 18.6% in 2021.

Who would have guessed things would change so dramatically in less than nine months?

Can Loan Participations and Securitizations Be Consistently Relied Upon?

A lesson from the last three years is that credit unions tend to be very similar in terms of loan and deposit growth. In 2019, liquidity was drying up and there were more sellers of participations and fewer buyers. COVID-19 hit in 2020, deposits surged, and everyone seemingly wanted to buy loans; sellers were few and far between. Today, it’s 2019 all over again, and the few buyers of loan pools can dictate their yields. In short, I question participations as a viable, long-term, and reliable solution for credit union liquidity management.

Securitizations are, due to their nature and the need to earn approval from a ratings agency, at best an option for the largest credit unions. For credit unions with the scale to securitize, this option opens up other investors for our excess loan volume; we’re not just relying on buyers from the credit union movement, Yet securitizations are still subject to the vagaries of the financial markets. If investors are concerned about the economy and credit losses, they’ll want higher yields, which might impact the ability for credit unions to continue to lend.

One of my favorite “credit union bedtime” stories is from March of 2009. We were on a call with one of our vendors about the state of the financial markets six months after the fall of Lehman Brothers. They advised that prime auto loan securitizations were priced such that investors were demanding 16%. At the time, our 60-month, A+ auto loan rate was around 5.5% to 6%. It’s impossible to price a loan at 6%, repackage it and pay an investor 16% without a huge loss. That’s why all the captive finance companies were “out,” and it provided an opportunity for credit unions to grab a big chunk of market share which we haven’t handed back; we may have lost some volume to the captives, but we’ve picked up business from the banks. This gain in market share happened because we were consistent in our approach, and we had money to lend.

To sum it up, buying and/or selling loan participations along with securitizations can augment loan and deposit consistency, but they won’t always be a viable option.

Consistency and Money to Lend

This month I celebrate my 34th anniversary in credit union lending, all at the executive level. I’ve built a reputation for generating consistent results. Over those 34 years, I’ve witnessed people losing their jobs and credit unions failing their members because of the carnage created by their “exploding” loan portfolios and loan losses. I never wanted to be part of that. I don’t get too excited when times are good, and I don’t have to dramatically curtail lending when the next recession hits either.

If your credit union wants to adopt the same kind of lending approach, it’s not enough to build your business model and remain consistent with your credit quality. Your credit union must have the same consistency when it comes to deposit products and pricing philosophy. You can’t afford to be reactive, dropping rates dramatically when deposits are growing quickly and pricing up when you need money; that’s been proven to be much easier said than done.

The need for consistency goes way beyond lending; it’s really about how well your credit union grows in the future. Consistency means the light switch is on all the time. When credit unions have had issues with their lending portfolio quality, for most intents and purposes, they turn off the switch. Members don’t respond well to management by light switch—and you may not have the luxury of using a dimmer.

Bill Vogeney is chief revenue officer and self-professed lending geek at $9.5 billion Ent Credit Union, Colorado Springs.

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