By Ray Birch
DALLAS—Many credit unions have mispriced their auto loans by 150 to 200 basis points, according to ALM First, which is predicting those decisions will be coming back to haunt their bottom lines in 2023 due to rising deposit rates.
But the mispricing is an issue the industry can “work its way through,” said Travis Goodman, principal at ALM First, adding the caveat that that opinion could change if there is another “shock” to the economy or the respective credit unions’ balance sheets this year.
“In the prime space I think we see some credit unions have mispriced their auto loans from 150 to 200 basis points in the past year,” said Goodman.
Goodman’s insights are appearing here as part of a CUToday.info series examining whether credit unions are underpricing auto loans and as experts question whether keeping rates low to continue to drive the auto lending engine is all good news.
Earlier in this series, one credit union CEO raised similar concerns around how credit unions are pricing their vehicle loans.
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 recent 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.
Goodman said this year some CUs are now finding out their ALM decisions have not been the best.
Travis Goodman
“That mistake, pricing loans too low, is coming back to challenge them this year due to higher deposit rates,” said Goodman, adding the scenario is developing as many credit unions also face of a liquidity crunch.
Captive Financing Returns
Goodman further urged credit unions should not be paying too much attention to the return of that keep their auto loan rates down should not be paying attention to the comeback in dealer financing incentives.
“You see the national commercials that are coming out touting one-half percent (loans) from the captives, but people forget that many times those rates are being subsidized by other things,” Goodman reminded.
Goodman noted credit unions, not banks, can sometimes afford to offer lower rates since they know their account holders better than banks know their customers, and can make decisions based on the individual.
But he also believes credit unions have been mispricing their auto loans over the last 12 months, adding the problem can also be seen in commercial loans.
“Credit unions can look to the secondary market for mortgage pricing, but you don’t have that with commercial lending,” noted Goodman. “So, there is a bigger disconnect here.”
Cheap Money, More Expensive Results
Many of the ALCO decisions that have been made came in the shadow of an environment of all-but-free money and has played a role in the pricing around auto loans.
“The cheap funding costs had allowed credit unions to make bad pricing decisions,” said Goodman. “They have been OK as long as those cost of funds remained cheap. I guess I shouldn't say it's fine, it's just more palatable. But the longer we're in this higher-rate environment, I think the credit unions are going to be challenged with increasing their deposit rates to maintain liquidity, and that's going to put pressure on asset prices—certainly on the assets they originated in the last year so.”
Goodman pointed out deposit rates are increasing very quickly. As CUToday.info reported, Fed Chairman Jerome Powell indicated last week during congressional testimony that more rate increases are likely on the way as the Fed seeks to tame inflation.
More Expensive Borrowing
Given that liquidity crunch, credit unions that want to keep lending growth at current levels will need to turn to more expensive borrowing from the other sources or raise deposit rates, Goodman reminded.
“They will be forced to increase their borrowing lines, or to liquidate their assets, at or below market value to keep the lending machine going,” Goodman said, adding that a number of credit union lending executives are not experienced with working their way through a rising-rate environment.
“They became accustomed to a different philosophy…with checking and savings account rates close to zero, and CD rates less than 1%,” he said. “We haven't really seen an environment like we have now since 2005 and 2006. I think there are some real behavioral challenges being faced now.”
Despite suffering the pain of compressed margins this year, Goodman believes credit union CFOs, ALCOs and lenders will slowly work their way through the challenge.
“It won’t be the end of the world,” he said. “But, if a second issue arises, whether it's a credit event or a liquidity event or something else, then what credit unions have done with their mispricing becomes more critical.”
‘Problematic for Some’
Goodman said if the second shock is a sharp economic downturn, those who have mispriced loans may have put the credit union’s future at risk.
“Nobody's predicting a Great Recession,” Goodman said. “But if there is some significant event, and you start having losses, there is a run on deposits, and you’re forced to liquidate assets to raise funds to pay for those deposits that are leaving…As I said, the mispricing can be overcome over time, unless a secondary issue arises, then these loans made over the last year will be really problematic for some.”
Goodman advised credit unions that may have priced their loans too low to examine the economic benefits and costs of their current assets.
“Is your loan pricing structure offering your institution more economic benefit on a risk-adjusted basis than a risk-free asset such as a Treasury? If the answer is no, then it’s time to reassess your options and find ways to increase your return and benefit your membership over the longer term,” he said.
The Next Step
Next, CUs should consider their liquidity position and what the next few months could look like if they run out of borrowing capacity and the below-market loans they have been adding are illiquid.
“If you’re in a borrowing position to fund new loans, make sure those new loans are priced correctly by using a disciplined approach and evaluating rates in a risk-adjusted framework,” he explained. “Liquidity risk is one of the most severe risks for credit unions and other depositories. When you couple that with credit risk or interest rate risk, it’s not difficult to see why a disciplined approach to pricing loans is vital for the health and sustainability of any financial institution.”