As we embark on a new year, credit union executives are challenged to be innovative while also managing risk amid uncertain economic conditions.
The disruption of the coronavirus (COVID-19) pandemic has compelled credit unions to consider new business strategies. One less traditional path to new product development is loan trading.
Loan trading can help credit unions reduce risk in a challenging economy and boost their loan-to-share ratios. For new product incubation, loan trading is also an alternative to starting from the ground up.
By tapping into the experience of an established financial institution through loan purchases, investors can find a streamlined way to access new loan types that may be thriving in an otherwise slow loan growth environment.
If your credit union is considering loan acquisitions as a precursor to a new product strategy, conducting periodic market and economic analyses will help you identify attractive asset classes. Macroeconomic trends, asset class growth outlooks, and other data will help you gain internal approval of a new loan type.
Your purchase plan should outline the types and sizes of loans you are looking to purchase, as well as geographic concentration as a way to diversify your current loan base.
Such a strategy should balance risk and net margin goals. To estimate prospective net margins of any target pool, core inputs include price, servicing fee, charge-off rate, prepayment speed, and remaining loan term.
In addition, you should use scenario analyses to estimate your risk tolerance on any pool.
At Alliant Credit Union, for example, we found an opportunity to invest in residential solar loans—a new asset class for our institution.
Alliant initially purchased a $50 million pool of loans from a credit union to gain exposure and performance history of the solar loan asset class. If the loans perform well, Alliant will be inclined to acquire future loans by working directly with a sourcing and installation company.
Typically, loans purchased from organizations that directly source and install solar panels are more profitable than those purchased from a bank or credit union. However, be prepared for the time- and resource-intensive process of integrating such an indirect partnership into your internal accounting systems.
Talking to a wide variety of counterparties and brokers experienced in your potential asset class can help you plan your new product entry. You can also review the bond ratings of relevant securitized financings to inform your decision-making process.
In addition, industry reports can help your institution estimate loan growth rates and forecasted market shares, and identify an asset class with a bright long-term future.
One lesson Alliant has learned is that upfront planning during onboarding a partnership helps mitigate unforeseen issues. Accounting, credit risk, finance, regulatory, and technology teams all have a significant role to play during integration.
Given the integration challenges and the time required for onboarding partnerships, many institutions find it more cost-effective to buy loan participations instead.
A new product loan pool may be sourced through a broker, platform, or other financial institutions. Each source has its pros and cons.
A broker may provide a wide variety of potential loan pools, as well as guidance on credit expectations and institutional knowledge, in exchange for a transaction fee.
Digital loan platforms provide information about a variety of loan products and historical transactions, but less-robust protections for purchasers than other channels. They’ll also charge an ongoing coupon clip and a platform posting fee.
A third option is direct partnership with a financial institution that already has an indirect partner. These transactions may take more initial effort, but they offer some unique benefits.
By partnering with a financial institution, you can build long-term relationships that streamline the future transaction flow, reduce trading costs, and improve access to asset class knowledge and best practices.
Regardless of macroeconomic trends at any given time, loan trading can help your credit union quickly access the benefits of new product development.
In today’s particularly challenging environment, loan trading provides an opportunity to help your credit union and its peers not only survive, but thrive into the future.
DAVID HOFFER is manager, loan trading desk, at Alliant Credit Union in Chicago.