Which factors will be most critical for credit unions to keep in focus?
Going into 2020, lenders must try to get clarity on key such key ideas as the economy, consumer confidence, risk and regulation. Also looming are the soon-expiring qualified mortgage patch and Fannie Mae and Freddie Mac moving out of conservatorship. Experts predict rates will remain low and the yield curve flat as credit unions seek to balance loan portfolios. The emphasis will shift away from auto loans to home equity, credit card and personal loan opportunities—and, of course, toward technology and other means of making loans more efficiently.
Federal Regulation & GSE Reform
Although the economy has shown signs of slowing, the National Association of Federally Insured Credit Unions, Arlington, Virginia, believes it will be healthy for a while yet, and CUs will be able to continue lending to members.
Carrie Hunt, NAFCU’s EVP/government affairs/general counsel, says that despite whispers of an economic downturn, such key indices as low unemployment, a modestly growing housing market and strong consumer spending point to a positive outlook. The Federal Reserve has also lowered rates, providing more opportunities to grow loans.
“NAFCU doesn’t anticipate a recession by year-end,” Hunt explains, “but with the economy showing signs of slackening, there is added pressure on lenders for more balanced lending portfolios. Portfolio diversity is nothing new, and the NCUA (National Credit Union Administration) remains concerned about concentration risk.”
Hunt also notes that capital is strong among CUs. But other pressures persist, including compliance with new current expected credit losses guidelines. These fundamentally change how U.S.-based financial institutions account for credit losses. Some experts encourage CUs not to delay setting up their process for collecting the necessary data, even though the effective date for CUs has been delayed to 2023. Meanwhile, NAFCU is lobbying rule-makers to leave CUs out of the equation.
“We’re working on getting credit unions exempted from CECL standards, which would restrict lending and an infusion of money into the economy,” Hunt says. “The NCUA is also looking at ways to reduce the impact of CECL, such as allowing credit unions to phase in the initial capital hit over a period of time.”
Hunt expects the Consumer Financial Protection Bureau (consumerfinance.gov) to let the qualified mortgage exemption, “the GSE (government-sponsored entity) patch,” expire in 2021 and encourages CUs to prepare for that shift. A qualified mortgage must be written following specific standards—the “ability to repay” rule. The patch exempts GSE-backed loans from having to abide by the full scope of rule.
In July, the bureau issued an Advance Notice of Proposed Rulemaking, seeking comments on the expiration of the GSE patch and possible revisions to the QM definition. “NAFCU supports a broader definition of a qualified mortgage, including an increase in the debt-to-income ratio. It’s now more important than ever for credit unions to have the QM safe harbor, so they can lend to and better serve their communities,” according to a comment letter NAFCU filed with CFPB in September.
“If the bureau ends QM exemptions, there could be a devastating impact on lending,” says CUES member Bill Vogeney, chief revenue officer for $6 billion Ent Credit Union, Colorado Springs, Colorado. “Fannie and Freddie have been approving and buying more mortgages with debt-to-income ratios over 43%. If lenders don’t step up and approve these loans for their portfolios, it will have the impact of eliminating perhaps as much as 20% of the home-buying market. Ent has approved a limited number of loans (mostly jumbos) that are not Fannie loans. To mitigate risk, Ent developed its own analysis of reserves to ensure it could cover any shortage of income for the payment.”
With the GSEs bolstering capital, it appears they’re preparing to move out of federal conservatorship, Hunt says. “We support an eventual exit but want to see statutory support with protections in place for credit unions. High volume lenders, such as Wall Street banks, should not receive more favorable loan pricing from the GSEs based on the number of loans being sold. Instead, loan pricing should be based on loan quality.
CUs “enjoy solid relationships with Fannie and Freddie and have good processes in place,” she adds. “We’re concerned for down the road, but we don’t anticipate the GSEs to be removed from conservatorship ... until after the next election.”
Other regulatory discussions that could impact CUs relate to payday alternative and business loans, as well as fintechs. “The NCUA is proposing payday lending alternatives legislation, and it’s a regulatory challenge that needs to be resolved,” Hunt notes. “We support PALs, which would safeguard credit union members. We also support increased business lending limits with longer maturity limits and would like to see an easing on the policy side for commercial loans.”Fintech regulation could help level the lending playing field. “Some fintech companies are creating their own loan products and now marketing directly to members,” Hunt says. “We believe regulators need to take a greater role in how fintechs operate when not partnering with a credit union or bank.”
Rates & Recession
According to Eric Salzman, co-founder of Blanton Research LLC, with offices in New York and San Antonio, low rates could boost lending. “However, I believe we will be in recession by the early part of 2020, which would limit net loan portfolio increases.”
Regarding the shape of the yield curve, Salzman notes that even if the Fed is in easing mode in 2020, there will be friction in the front end of the yield curve not seen in previous easing cycles.
“With the increase of the federal budget deficit, the supply of Treasury bills will continue to increase at historically high levels,” adds Salzman. “The Fed has, in recent weeks, been forced to provide daily liquidity to the all-important Treasury repo market. This is in response to the supply of Treasury bills coming to market that has overwhelmed market liquidity.
“Additionally, the Fed recently stated that it would begin a more permanent (as opposed to daily operations) facility to purchase about $60 billion Treasury bills per month at least until the middle of 2020. We will have to see how this plays out, especially if supply continues to increase,” he adds. “Subsequently, the yield curve may not steepen as much as in past Fed easing cycles.
“An economic downturn will hit many companies especially hard with the amount of leverage they have amassed over the last five years,” Salzman continues. “It would also impact businesses that are leveraged with cheap funding hard. Usually, the first thing cut when companies are strapped to meet debt service is employment. Extraordinary low unemployment has been the cornerstone of economic growth over the past few years. Unfortunately, I think we will begin to see unemployment and underemployment rise substantially in 2020. With that in mind, we may see the 10-year Treasury rate challenge its all-time low yield of 1.36% set in 2016.”
Vogeney believes the bond market is overbought, and the 10-year Treasury bond yield is lower than it otherwise would be. However, he notes that if long-term rates stay below 2%, it could be a good year for mortgage refinances.
The Car Loan & Mortgage Markets
Of course, market trends make a difference in car and home lending.For example, declining car loan market share, fewer car sales and a shift from indirect lending will impact lending in 2020.
“New car sales are down for the year, with 16.9 million units sold in Q2 2019, down from 17.3 in Q2 2018,” explains Bob Child, COO for CUES Supplier member CU Direct, a CUSO based in Irvine, California. “This is the first time sales have been down since 2014, but previous levels were likely due to pent-up, post-recession demand, and levels are now normalizing. Based on our survey of eight economists’ models, I don’t expect car sales to exceed 16.5 million units in 2020.”
Car buyers may be feeling edgy too, with NAFCU’s Credit Union Sentiment Index reaching its lowest point (June 2019) of the Trump presidency. “Consumers are uneasy with trade tariffs,” notes Child. “And if the president doesn’t roll back the tariffs on autos, it will further impact consumer confidence. We believe he’ll push back the tariffs but leave it out there as a threat.”
Peaking loan-to-share ratios have caused CUs to pull back on auto lending as well, with market share dropping in Q2 to 19.8%, down from 22.1% in 2018.
“Surveying 50 large credit unions and auto lenders, 57% anticipate auto lending volumes to be either flat or down for 2020,” Child adds. “These credit unions are reducing their auto lending ahead of a slowing economy, and most want to optimize ROA (return on assets) while focusing on mortgage, home equity and commercial lending.”
Indirect auto lending won’t be a spigot for growth in 2020, either.
“Credit unions aren’t looking to indirect lending as a growth engine, and the environment for risk is not conducive,” says Lisa Bonenfant, VP/credit unions for Experian, a CUES Supplier member based in Costa Mesa, California. “There is also a greater emphasis on attaining more balanced loan portfolios.”
Child says home prices and sales are additional factors that will influence credit union lending in 2020. Flattening home prices are expected to rise a modest 4.3% in 2019, he reports. In addition, falling home sales are projected to increase only 1.7% in 2019, with a seasonally adjusted annual rate of 5.3 million units sold in June. Soft home price growth is tied to the job market, Child notes.
“Plus,” he says, “there’s not enough affordable housing to meet demand, especially for first-time millennial homebuyers, with Freddie Mac estimating 370,000 fewer homes being built in 2019 than needed to satisfy population growth. Much can be placed on the shoulders of boomers, comfortable in their homes and low mortgage rates. I don’t see them moving out of their homes for the next decade. Compounding the challenge are builders ignoring the lower-priced home market, simply because they’re not as profitable.”
However, 2020 could be a banner year for home equity financing. Child anticipates 25% growth in this segment. “If consumers are staying in their homes and building equity—and [if] rates stay low—they’ll consider this financing option for home improvements, car purchases and debt consolidation,” Child says. “There are point-of-sale solutions that can help serve members and bridge the gap of a labor shortage.”
Areas of Potential Growth
Naturally, regulation, the economy, rates and market trends all impact underwriting. “And this leads to discussions of automated decisioning, which will have to grow substantially to support loan growth,” says Bonenfant. “We’ve seen some credit unions with very low automated decisioning levels, and most are looking to improve the pace and consistency of their decisions.
“There are credit unions with several hundred loan officers approving loans,” she continues. “Most cannot sustain this and stay effective and competitive, especially for prime borrowers who don’t need a hands-on decision. Instead, it requires understanding your members’ data attributes for consistent, operationally efficient decisions. Watch for the increase of plug-and-play lending strategies, as credit unions seek to expand their membership and loan portfolios.”
Ent CU decisions about 45% of consumer loan applications immediately based on credit scores and specific application attributes.
“We think we can get that number to 50%, maybe 55%, in the next 12 months and are striving for 60 to 70% in two to three years,” Vogeney explains. “I’m not sure we can accomplish this without machine learning processing additional information, such as account data and data from third parties. Instead of having a rules-based decision engine in our loan origination system—processing 10, maybe 15 pieces of data—machine learning can handle hundreds if not thousands of pieces of data. It will help us to approve more people faster.”
New credit scoring approaches may help too. In July, the House revived its effort to allow non-traditional data in credit scores. The idea is that the inclusion of such items as rent and telecom payments when determining creditworthiness could help consumers build their credit profiles.
“My understanding is that UltraFICO (a new score being piloted) will allow consumers to upload their bank account history (transactions, average balances, non-sufficient funds info, etc.),” says Vogeney. “And for those with limited credit or credit problems, there may be benefits. I’ve seen where the average consumer (a 640 score) could see their score increase by 10 points, perhaps as much as 20. However, there have also been some concerns voiced by consumer organizations.”
Some of this shift is consumer-driven, by those who want to improve their scores. Lenders are also enabling consumers to upload bank account information to improve the chances of approval. And the bureaus have an opportunity to offer a product that may allow lenders to approve more applicants.
“However, I don’t think the net impact will be significant—we’re probably talking about qualifying 2% more people for loans,” Vogeney says. “And if lending to an existing member, credit unions may already consider this information.”
Experian released a similar product to UltraFICO in 2019 called Experian Boost.
“These new means of identifying creditworthy consumers is a trend I expect to continue,” says Alpa Lally, Experian’s VP/data business/consumer information. “By incorporating bill-payment information, lenders have a clearer picture of a consumer’s creditworthiness, beneficial for those with limited credit histories and scores between 580 and 669. Results also show that 90% of ‘thin-file’ consumers who use Experian Boost see an increase in their score, and 24% moved to a ‘fair’ tier. And two out of three consumers see an average increase of more than 10 points.”
Technology also could support growth in lending areas currently less of a focus for CUs.
For example, “growth could come from the resurgence of personal loans, notably through fintech innovation, which has made personal loans ‘cool’ again,” Bonenfant says. “Fintechs are providing flexible and fast lending methods to attain these loans, and it has created new consumer interest—especially among millennials who may be more averse to credit cards or don’t qualify for home equity financing. They’re not massive loans—but, with a capped amount, they present a different model from credit cards and another way to balance a portfolio.”
CUs should also look to enhance their card programs and improve rewards. “Programs must keep pace, and historically credit unions have not focused on these programs,” adds Bonenfant. “Ensure members have lucrative credit lines and you’re delivering the right offer to the right member at the right time. Research indicates a positive correlation between card usage and larger lines.” cues icon
Stephanie Schwenn Sebring established and managed the marketing departments for three CUs and served in mentorship roles before launching her business. As owner of Fab Prose & Professional Writing, she assists CUs, industry suppliers and any company wanting great content and a clear brand voice. Follow her on Twitter @fabprose.