First, borrowers took advantage of historically low rates by refinancing and paying off home equity loans. Then the Covid-19 economic downturn eroded origination volume further, with fewer borrowers qualifying for more stringent underwriting standards. Meanwhile, some consumers have relied on money from stimulus checks instead of loans to fund big-ticket purchases. Other consumers have simply squirreled away these funds in deposit accounts before ultimately deciding how to spend it.
In January, credit union loan-to-asset ratios fell to 62.6%, the lowest level since 2015, according to CUNA Mutual Group. Loans grew by just 5.7%, well below the historical average of 7.2%. Meanwhile, deposits grew 18% last year. As a result, financial institutions are flush with deposits without many compelling options for investment.
Though interest rates have climbed since the lows of December and January, all these factors continue to pose a challenge to effective balance sheet management. Until the economic climate improves, credit unions and banks will need to use creative strategies to cope. Here are five of them.
1. Improve portfolio retention
The refinancing boom of the last year may be waning, but prepayments still threaten to snatch loans off your books thanks in large measure to rising asset prices and federal stimulus. In other words, borrowers have multiple sources of money to pay off their loans.
How can you make it worthwhile for borrowers to stick around? Could it be a new product or service that can respond to changing market conditions? Or is it simply a matter of demonstrating how much you value them. For example, consider offering borrowers with less than 75% loan-to-value a no-cost refi. If the choice is between paying off a small loan or incurring fees they won’t recoup with a refi, most borrowers with means will opt for the former. Make their decision a no-brainer.
2. Think long-term
Balance sheet management is both an immediate- and long-term issue, which is why it’s imperative to look several years out. While balance sheets are flush with cash now and you are rightly focused on the challenges it poses today, be mindful that this won’t always be the case.
Eventually, your customers will put the money they have to use, and they will come back to borrowing. It’s a delicate balancing act, but when loan volumes pick up, liquidity will be essential. Future liquidity will be a function of what you do today. Don’t let the challenge of finding yield now push you into long-maturity investments that you may regret later on.
3. Stay nimble
Markets change, interest rates fluctuate, pandemics eventually get under control — which is why the playbook that worked five years ago (or even last year) needs updating. Today’s balance sheets require more than simple deposits and loans. For example, you might consider selling your institution’s longer-term mortgages. Another option is getting involved in unsecured loans with short average lives so you can tap cash flow regularly. When we move into a higher-yield environment, you can take your monthly liquidity and move it into loans.
4. Cultivate reliable third-party partnerships
For years, credit unions and banks have looked at fintechs as competitors. But in this environment, financial institutions should embrace fintechs as partners to drive loan originations. Whether it’s education loans, solar loans, or other unsecured loans, these companies offer products that financial institutions may not have access to otherwise, and partnering up could give you a pipeline of diversified loans.
It’s also a win for the fintechs, many of which don’t yet have the balance sheets to drive the amount of revenue they need to please investors. By teaming up with credit unions and banks, they can leverage those institutions’ balance sheets.
Make sure to do your due diligence when working with any partner. Monitor that these firms are taking the appropriate credit risk so loans don’t deteriorate and you won’t suffer losses.
5. Consider Loan Participations
Players like Aliro have introduced a new way to facilitate loan participations, helping credit unions and banks effectively manage balance sheets and drive income. With a loan participation, marketplace lenders serve as third-party origination sources who then work with a “seller” institution. The seller takes the loan on its own balance sheet and sells partial interest to buyers.
Technological innovations have made it easier and more cost-effective for credit unions and banks to use loan participations for balance sheet management. Buyers of loan participations earn returns on assets without having to do the marketing, research, or servicing that in-house origination entails. Sellers, meanwhile, have the opportunity to reduce in-house manual administration, manage portfolio risk, and earn non-interest income through loan sale premiums and loan services fees.
In addition, Aliro offers a proprietary “forward flow” feature that allows buyers and sellers to better plan and anticipate supply and demand in the lending marketplace through recurring loan participations, similar to a subscription.
Balance sheet management is always a challenge, but in today’s low interest rate, tentative economic climate, it can be especially difficult. That’s why thinking creatively is a must. Thanks to technological innovations, there are more tools than ever to get the job done.