By Ray Birch
CLAWSON, Mich.—The mispricing of loans by credit unions, particularly auto loans, could lead to some CUs facing earnings struggles in the near future, according to one analyst who is also recommending steps to address the issue.
Charley McQueen, president and CEO of McQueen Financial Advisors, agreed with others who have suggested too many credit unions were guilty of keeping auto loan rates far too low for far too long, not recognizing amid the short-term boost in volume how there would be a price to pay in the longer-term.
McQueen added he believes decisions made by many CFOs, many of whom are younger and who have not during their careers experienced an extended period of rising rates, are affecting investments and liquidity.
As CUToday.info has reported, consumers today have the opportunity to grab some of the highest returns on their deposits that they’ve seen in 15 years. Top-yielding online savings account rates are now just north of 5%, the highest since 2008, and much higher than last year’s 0.8%.
“All institutions are paying much higher rates on deposits right now, it's just not smaller institutions, and it's because people are spending more money than they make, just to get by—to buy groceries and things. They don’t have the money lying around in deposit accounts like they used to,” said McQueen, who noted draw down of personal savings is forcing financial institutions that had enjoyed record-levels of low-cost core deposits—to begin to pay up to maintain those funds and attract new deposits.
There are also consumers who are nervous about bank failures and what levels of deposits are insured, McQueen said.
“So, we see people who are reducing their exposure little bit. But most of our institutions have actually seen deposits increase or be flat over the past three months,” said McQueen.
Where credit unions have also not done well has been in tightening the loan spigot when necessary, said McQueen.
“They're having lots and lots of loan growth. When you have loan growth that reduces your cash position. And when you have a little deposit runoff it reduces your cash position,” he said. “Liquidity is at a premium. Credit unions should not have been putting all these loans (in the past year) on their books.”
One Particular Issue
As other analysts have also told CUToday.info, McQueen believes a particular issue has been credit unions underpricing their auto loan rates even as the Federal Reserve aggressivley raised rates.
“Credit unions mispriced loans, especially auto. They kept them too low and now they're dealing with that and they have to make balance sheet adjustments,” continued McQueen. “Your balance sheet is not marked to market. What that does is produce a tougher earnings position. I think the next thing we’re going to see is credit unions struggling with earnings.”
Those earnings struggles will be a challenge for many, but McQueen does not believe they will lead to any failures, although he suspects it will sway some CUs to consider mergers.
“I do think there are a number of institutions that didn't properly prepare for the situation we're in and they're going to have a very difficult time with earnings and their balance sheet,” he said. “There's long-term, good balance sheet management strategies. And a lot of people have not paid attention to them. It was, ‘Hey, I don't want to stay short with my investments because I'm not making any money. I'm going to go longer.’”
In doing so, McQueen asserted, those CU executives lived for the short term, and disregarded the longer-term impact to the balance sheet.
“They reached for a yield and invested longer,” he said. “Now these investments they may have to sell to drive liquidity are a little bit underwater and that hurts them. You either sell the investments and take the losses, which is no fun, or you borrow money.”
Competition Remains Fierce
And is if all that weren’t challenging enough, the heated fight for deposits isn’t cooling, McQueen said.
“We're seeing six-month to one-year CDs at 5% and money market rates at 3.7% to 4%,” pointed out McQueen. “And this is not a small institution problem. American Express is paying nearly 5% on their money market accounts. Everyone's paying these higher rates right now to attract deposits.”
McQueen reminded that moves by the Federal Reserve, with its quantitative tightening, is also having an effect.
Charley McQueen
“We're shrinking money supply, which is pulling money out of the system and people are spending more money because of inflation,” he explained. “The combination of the two makes it tough when you just work with primarily individuals.”
How Credit Unions Should Respond
What do CUs need to do?
“You always, every day, have to do the basics—the blocking and tackling,” McQueen advised. “What that involves is writing loans at appropriate rates. Don't stop lending money, but you have to control the loan growth. You need to focus on your core membership. Many credit unions are doing indirect lending and looking to get loans from other places. But what they don't realize is they're not getting deposits anywhere except from their members. You need to balance out the deposits you're getting with the loans you’re getting from that membership base. If you're making loans to your core membership base, life is simple and easy.
“But if you decide that you want to do indirect lending, buy loans from the marketplace, or do something different, you then need to realize that you need to borrow funds to fund these indirect loans.”
In McQueen’s own review of the broader market data and where credit unions stand, he sees pricing minimums most CUs should be observing.
“If I'm going to borrow money from the Federal Home Loan Bank, let's just call it 5%, I've got to start with 5% (for the CU’s loan pricing). Then I've got to factor in my expenses. I also need to put in money for loan losses and CECL. And then, on top of that is my return—the ROI I need to have. So, when doing indirect lending or buying loans today, you're very quickly into the sevens, if not 8%—the lowest yield you should be booking.”
The Generation Gap
It’s advice in which a generation gap may be apparent, he added.
“Our company is dealing with a couple people who have had some problems, helping them work through them, and they are younger CFOs,” explained McQueen. “What I'm seeing many times is the CFO may not have as much negotiating experience dealing with people that have different interests. A great example is a CFO who bought a bunch of long-term, fixed 30-year mortgages over the past year. It was because a broker was telling him it's a good idea. I think a lot of these younger CFOs do not have the skill set or the knowledge to ask the right questions—such as is this really a good idea? What happens if rates go up? They just listen to people who have different motivations.
“Let’s use a used car salesman as an example, and I am just pointing to how people often perceive used car salesmen,” he continued. “But the used car salesman only gets paid if you buy that car. He couldn’t care less about what the payment is, how it affects you, how it affects your credit score, what happens to you in your life. All he wants is you to buy that car. And a lot of times bond salesman are the same way—there's good ones in this world and bad ones.”