FRISCO, Texas–Over the last eight years or so, credit unions have seen steady, strong often double-digit loan growth, with much of that the result of auto lending. But as loan terms get longer, CUs need to understand how risk is changing, according to one person.
Vehicle loans make up approximately one-third of total CU loan allocations (following mortgages at about 50%), and there has been a steady transition in the loan mix, with the majority of auto loans (55%) for used cars. The reason for the change is no secret: the average new vehicle cost is more than $37,000.
Speaking to Catalyst Corporate FCU’s Economic Forum here, Casey Peterson, senior advisor with Catalyst Strategic Solutions, covered a number of topics during remarks themed “Enhancing Performance of the Loan Portfolio.”
Peterson noted that despite all the volatility of recent years, margins have remained relatively stable, and CUs have been able to continue to maintain those margins even as rates have declined.
“The one thing we have to factor in in overall earnings is we have to keep operating costs in check,” he said. “It’s really the only thing we can control. You really need to look at the credit union from an efficiency standpoint, including in the loans you put out.”
In looking to auto loans, Peterson urged credit unions to understand the market and who it is they are trying to target. Specifically, he said when it comes to what he called the “most-talked-about generation,” Millennials, it’s important to understand how they are different.
“Are they predisposed to leasing, rather than the more traditional means of purchasing a vehicle?” asked Peterson, who said leasing has been underutilized by CUs, especially as a means of pushing into new markets.
Longer Terms
Peterson said he and Catalyst Strategic Solutions have heard from credit unions in recent years that want more guidance around longer terms on auto loans. He noted the average auto loan term today is 60 months; 10 years ago it was 59 months. In 1975, it was 34 months. (As an aside, he said the longer terms and longer periods credit unions are staying on the road has also led to new issues for manufacturers, including wear and tear on interior components, and technology that gets old quickly.)
One Hypothetical
Peterson created a hypothetical set of scenarios for a vehicle priced at $50,000 with a rate of 4.5% over different loan terms. A vehicle that is financed for 60 months gets to breakeven for the credit union in around 12 months. On a 72-month term, it’s approximately 27 months before it’s breakeven for the CU. At 84 months, a CU sees breakeven around 55-60 months, and at 96 months the lender doesn’t see breakeven until 64 months, he said.
Another challenge with longer terms, he reminded, is ensuring gap insurance remains effective.
Peterson urged CUs to look to alternatives in auto loans, such as leasing and new auto balloon loans.
“The idea behind this is that if you have a membership base that is trying to keep their payment down, they are looking at options: a longer term, a lease?” he said.
Thirty percent of the new car market is leases, observed Peterson. New auto balloons are very similar to leasing products, but require strong consideration around residual values, he added.
Real Estate Loan Quality
Meanwhile, looking to real estate loans, Peterson said the biggest challenge isn’t the rate being charged or earned, it’s the exposure to the market, especially if there is any economic downturn. “I think we can manage through the interest rates,” he said.
Peterson wants credit unions to reconsider mortgage loans, including beyond just purchase and finance loans with the standard 15- and 30-year terms. He said home equity lines, home equity loans and refinances offer strong potential, as well.
He reminded the current spread between the 30-year fixed rate mortgage and the 10-year Treasury is 193 points. The average spread over the last 14 years has been 183 points.