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Funding: The key to maintaining robust lending portfolios

By: By Perry Jones, VP/Portfolio Manager

I’m sure it comes as no surprise that maintaining a healthy loan portfolio is one of the most crucial performance components to help credit unions defend against the industry-consolidation trend. If your credit union struggles to add quality, higher-yielding assets, you may eventually find your institution's long-term viability in question. Higher-yielding loans help finance increasing costs stemming not only from higher regulatory and compliance expenses but also from maintaining technology infrastructure to protect, as well as satisfy, the membership. To that end, I’d like to emphasize how many credit unions grow and maintain a robust loan portfolio.

Reviewing the opportunities for loan growth

While you’re already aware of opportunities that exist for loan growth, let’s briefly review a few along with recent growth trends:

  • Indirect lending. In the last five years, indirect loans have more than doubled and now represent nearly 20% of all outstanding loans. The idea of indirect lending may conjure up negative connotations, but properly implemented and managed indirect lending programs have proven to be a springboard for loan and membership growth for many credit unions.
  • Member business loans (MBLs). MBLs have expanded to $66 billion and now represent 8% of total loans. Much like indirect lending, a properly implemented and managed MBL program can lead to healthy loan and membership growth. The great news is that you can readily partner with an existing MBL credit union service organization (CUSO) who can assist with policy and procedure development and then perform other services, such as underwriting.
  • Employing commercial loan officers. Aside from finding the right MBL CUSO partner, attracting and appropriately incenting one or more commercial loan officers is another key component to a successful MBL program. Entering this market provides an opportunity to deepen relationships with existing members, as well as better serve the communities in which the credit union serves.
  • The loan participation market. This market continues to expand as credit unions with high loan-origination volumes are increasingly accessing this market to transfer loans to credit unions in need of additional loan growth. Total loan participations purchased and held on balance sheet have also more than doubled in the last five years.

Funding your portfolio

Growing or maintaining a robust loan portfolio takes effort, and generally does not occur at sufficient levels organically. Sure, credit unions greatly benefit from positive word of mouth, but the growth required to stay relevant takes a coordinated internal effort and a well-planned strategy to attract new members, loans and deposits.

However, even with a well-planned strategy, overall imbalances will occur between assets and liabilities, as well as the timing of cash flows of those two balance-sheet components. To smooth the seasonal fluctuations in the deposit base, and bridge the short-term liquidity gaps created by mismatched cash flows, credit unions are increasingly sourcing external funding. External funding primarily consists of three sources: overnight and term borrowings from a Federal Home Loan Bank or a corporate credit union, non-member deposits, and public deposits. These diverse sources of liquidity provide a stable source of funding and can range from overnight to longer-term funding.

While total shares at credit unions have grown 30% in the last five years and continue to represent the majority of funding, total liabilities, or borrowings, have increased nearly 89% to over $48 billion. Call report data shows that funding is being sourced from non-member deposits and public deposits at an increasing rate. In fact, funding from non-member deposits and public deposits has increased 2.6x and 2.2x, respectively, in the last five years. Non-member deposits recently exceeded $8.5 billion while public deposits breached $4.8 billion.

These three external funding sources only represent about 5.4% of total funding, but their importance should not be minimized. As part of sound liquidity management and planning, many credit unions incorporate most of these external funding solutions, as well as selling loan participations, into their liquidity policies and contingency funding plans. And, as the data demonstrate, credit unions are accessing multiple sources of liquidity to fund their assets. These funding solutions provide great efficiency, but can lead to a higher cost of funds over member deposits.

Basically, to make sure your credit union is properly preparing to fund its loan portfolio, you should keep these best-practice tips in mind:

  • Secure multiple sources of liquidity. Strategically managed credit unions consider and employ various funding sources to meet members’ loan demand, fund existing assets, and mitigate risk. To do so requires sourcing competitively priced liabilities and having access to diverse funding sources.
  • Monitor your liquidity position. With the summer months fast approaching, monitoring your liquidity position may become a higher priority within your organization. Within organizations that operate with lower levels of on-balance-sheet funding, monitoring could be done on an hourly basis, whereas other organizations may be in a position to monitor liquidity on a weekly or monthly basis.
  • Test your sources of external funding. This is an important component of ensuring that liquidity plans and policies remain up to date. Our internal and external environments are constantly evolving with changes in people and systems. By periodically testing sources of liquidity, you can demonstrate the procedures necessary to borrow and move funds, and ensure that the right people are authorized and can gain access to your liquidity sources when needed.
  • Maintain sufficient access to funding as you grow. If your organization maintains sufficient access to external funding as growth occurs, business strategies evolve, or conditions change with the composition of existing liabilities, you will be prepared when liquidity tightens or when state or federal examiners become interested in your evolving business strategies.

Maintaining multiple and diverse sources of liquidity and establishing ongoing monitoring, testing and maintenance of your credit union’s liquidity plans is instrumental to managing and demonstrating the sound liquidity posture of your organization. And, demonstrating this sound liquidity posture helps you maintain a robust lending strategy that propels the organization toward the desired growth objectives while maintaining long-term viability.