WASHINGTON—Data show that as the Federal Reserve raises rates credit unions are gaining significant share of the total auto lending market—but is that good?
One credit union CEO, who has already warned the too many CUs are putting too many low-rate vehicle loans on the books and will pay the price as net interest margins shrink, said his concerns are growing as CU share of the overall auto lending market reaches record levels.
The issue has caught the attention of national media, with the Wall Street Journal reporting under the headline “Auto Loan Interest Rates are Skyrocketing: No One Told Credit Unions,” that at the time of its year-end reporting, credit unions charged an average interest rate of 5.94% for used cars in third quarter, while banks were charging an average rate of 8.36%.
According to CUNA Mutual Group’s latest Trends Report, credit union new-auto loan balances rose at a 20.1% seasonally adjusted annual rate in November 2022, significantly above the double-digit pace set during 2012-2018.
“I’m not surprised that credit union auto lending is gaining even more steam,” said Evan Clark, CEO of the $850-million Department of Commerce FCU about the rapid CU auto loan growth. “And the leaders of the credit union movement are so proud of the fact that credit unions now own a lion’s share of the auto credit market. Really? The reason is that credit union rates have been so far out of line with the going rates in the market.”
Balance Sheet Squeeze
That’s a concern for credit unions that could find themselves locked in a balance sheet squeeze created by a combination of low rates loans on the books and liquidity pressures as deposits are priced upward by other providers.
What has been taking place, according to Clark, is credit union CFOs and ALCOs have not been repricing their loan rates upward at the same pace as bank and captive finance lenders have, even though the Federal Reserve has been steadily increasing rates for the past year as it seeks to fight inflation. As a result, dealers “fell in love with credit unions” and are now sending them all their business, Clark said.
“Meanwhile the market has been saying rates should be so much higher,” Clark explained.
In October of last year, as credit unions were wading more deeply into a liquidity crunch, Clark offered these insights:
“Too many credit unions are putting on too many loans at too-low rates,” Clark stated in the report, pointing to Treasury rates at the time.
Market ‘Context’
“The Treasury rates give us context,” Clark said. “How many credit unions are currently doing car loans with rates less than 4.28%? Let’s look at the math. The rate for a two-year Treasury, a risk-free investment, is 4.28%. That’s the average life of many car loans—though it could be that the average life is actually closer to three years with terms extending. Add CECL losses of 50 basis points to the 4.28% and you get 4.78%. What the market is telling us is that no credit union should have any rate on a car loan below 4.78%.”
Clark said he had been hearing from some credit union leaders who have concerns their loan demand will dry up if rates are raised to too high.
“The market is telling you that is where your loans should be priced,” said Clark about the 4.78% figure. “I call it institutional suicide if a credit union’s rates are below that for one simple fact—how are you going to fund your loans if you have to go to the Home Loan Bank and borrow? Their rates are very competitive and yet they are typically 20 to 50 basis points higher than the applicable Treasuries. Raise your loan rates.”
A ’Messed Up’ Curve
Don’t look for those pressures to lessen anytime soon, Clark added.
“There’s lots more to this. Fed funds are now almost at their highest rate on the yield curve. So, what that’s telling you is that the market is already building in the next 25-basis-point move,” Clark said. “But look at the rest of the curve. The 10-year is at 3.63%. The two-year is at 4.45%. The five-year is at 3.81%. That is a curve that is messed up.”
Clark emphasized how clear the Fed has been about its approach to raising rates until inflation is tamed.
“Chairman Powell has been as transparent as a pane of glass,” Clark said. “They’re raising rates and they will keep them elevated until inflation is under control. But there’s a problem. With the rally in the ten-year, mortgage rates have come down. If they come down much more it could stimulate housing demand. And, as we know, housing is one of the big drivers of our economy. And if that gets stimulated it could exacerbate the inflation issues we have that are primarily job related.”
Evan Clark
Red Hot Market & Rising Rates
Clark pointed out the jobs market right now is red hot, and Fed officials have recently indicated that will only add to the likelihood rate increases will continue.
“Unemployment is at a 50-year low. Jobs creation is higher than even the wildest estimates. Job openings, although off their peak, are still three to five times their historic mean,” he said. “Yes, inflation has come down, but it’s primarily energy related. I’m with Chairman Powell, there’s still lots of work to do.”
Clark pointed to the fourth quarter of 2022 when there were record draws on lines of credit at Home Loan Banks. And, as CUToday.info reported, borrowing in the federal-funds market hit $120 billion on Jan. 27, the highest one-day total in Federal Reserve data going back to 2016, according to a Wall Street Journal report.
“And I mean really big numbers. There were record numbers of nonmember deposits being raised by credit unions. Again, really big numbers,” Clark said.
As a result, Clark noted more credit unions have been looking to a new outlet for funds.
“There are credit unions trying to sell pools of loans into an environment where liquidity has dried up,” he said. “They are shocked when they are given below-par price offerings on their loans. But they shouldn’t be, because they are making loans at rates that are below market.”
Credit union deposit rates are a concern, as well, added Clark.
“Credit union deposit rates are terrible,” he said. “If credit unions are having a hard time getting new CD money into their credit unions that should tell them one thing—their rates are too low. The solution? Raise your rates until you start to see deposits come in. When that happens that’s an indication that your rates are high enough.”
One Solution
Clark said the solution for vehicle loans is equally simple.
“Find a brokerage firm that you like and ask them to price the loans that you are putting on your books,” he said. “If you can live with the price they are quoting you then your loans are probably at the right interest rates. If not, then the solution is simple—raise your rates. Even if it slows demand, your bottom line will like you a bunch because you’re giving yourself the loan income you need to cover the rising cost of funds…And I don’t think we’ve seen the worst of the liquidity crisis yet.”