A HARD PLACE: Between member demand and a CU's investment portfolio

TOWNSHIP OF WASHINGTON, N.J. -Richard Rays has an answer for credit unions faced with the problem of not having enough money to satisfy member loan demand. That embarrassment of riches is faced by a growing number of credit unions these days, and it's beginning to have an impact on the investment portfolio as well as the lending capacity of some. But for every credit union that may be loaned out, there is a credit union somewhere that is hungry for loans. And making that connection is the answer, said Rays. Called loan participations, this concept has been coming into its own of late, and Paragon Services Inc., the credit union service organization (CUSO) of Paragon FCU here is the recognized leader in packaging such swaps. Rays says the solution will work for most credit unions-regardless of size- even low-asset credit unions. Gone are the days when credit union investing was a simple affair. Investments helped to meet a CU's income goals and excess funds went to the corporate CU or into an insured CD at a bank, said Rays. Vanilla isn't the only flavor of ice cream any more, and neither are loans or investments. But instead of whining for the "good old days" when a modicum of applied thought led to an understanding of the stock market, the monetary system and the national and global economy, why not keep the money within the CU system, he asked? He wasn't the only one doing the asking, either. Chip Filson, president of Callahan & Associates, the CU research group and "think tank" in Washington, D.C. has been advocating a "secondary market" for all kinds of credit union loans for some time. Charlie Felker of First Empire Securities, New York, calls loan participations a "great way of reallocating liquidity within the CU system." First Empire has been packaging and brokering loan participations for its clients since the beginning of the year, he said. As a securities broker to credit unions, Felker said he's seen the changes in CU investments go from long-term to short term in order to accommodate the need for cash when loan demands goes up. This can hamper low loan-to-asset CUs because they generally make longer term buys as loan substitutes. "They usually rely on their portfolio more," said Felker. And now that NCUA has put increasing demands on CUs to make more loans, some have had to lose the higher yield on the sale of those investments in order to raise the money to make member loans. The least favored option, he said, is for a CU to reduce loan limits across the board. Loan participations can be "a pressure relief valve for them," he said. And being a former NCUA investment guru, Felker is familiar with Regulation 701.22, the reg that governs loan participations. Felker estimated the market for participation loans to be between $500 million and $1 billion. Out of a total $270 billion CU portfolio, that may be seen as small, but "it's a developing market," he said. "The problem is that there's a whole lot more buyers than there are sellers." Rays sounds like a visionary when he waxes on the idea, and is on a mission of sorts to inform and educate credit unions about the options awaiting them. "The biggest stumbling block we see is that credit unions just don't understand them. They're afraid of them. Board's get starry-eyed, especially boards at small credit unions. They worry that they're buying someone else's troubles, but they're not. Face it, large credit unions have CPA's and specialized investment types to monitor a portfolio. That's all they do. A small credit union manager typically wears so many hats that he or she doesn't have the time to do it. But the only way that small CUs can grow and become more competitive is by making more loans. But once they use up excess liquidity, where do they go?" The eyes needn't glaze over, said Rays. Paragon set out to change the perception by producing a video called "Loan participation Programs for Credit Unions," and adding a 34-page written guide called the "Credit Union's Guide to Loan Participation." There's also a shorter, four-page FAQ (frequently asked questions) pamphlet on the subject. Rays believes that loan participations are much more than a "last resort for cash-strapped CUs. They are a strategic weapon of the future." Paragon has arranged a $10 million loan participation deal with Boeing CU, Tukwilla, Wash., and another $10 million deal for ESL Federal Credit Union, Rochester, N.Y. It has just signed a deal with XCU Capital Corp. Inc., Carlsbad, Calif., the CUSO of Xerox FCU, that is a partnership of sorts, said Rays. Paragon will have an employee on site there to work on loan participations. This will facilitate deals on the west coast, he said. Loan participations come in many forms, said Rays, but the bulk of them are collateralized loans, mostly auto loans, but there sure are exceptions to that rule, he said. For example, Progressive CU in New York sells its loans to other credit unions. Progressive's membership include New York taxi drivers, who borrow the money to buy the medallions for their cabs. Medallions are limited by the city government, and their value has continually risen over the years. A medallion can cost $150,000 or more. "I don't think they've ever had to foreclose on a medallion loan," said Rays. Even skittish loan participation buyers can take measures to ease their anxiety, Rays said. It's all in the agreement, which can be written to suite. Basically, a loan participation is funded by two or more CUs that each share the principal, interest and risk. But that risk is proportionate to the ownership, or as stipulated. And agreements can be written with recourse, where the hit (if there is default) is taken by the seller; or without recourse (where the buyer takes the hit). A seller can also assume a partial recourse in the event things go bad. It is not uncommon for loan participations to out-perform investments. If the loans are underwritten according to sound practices, the risks are minimal. And if they are priced appropriately, may prove a better investment than like-term Treasuries, Agencies or Certificates of Deposit. (For example, where paper is priced at 9% and experience demonstrates a strong track record where charge-offs have never exceeded .3%.) Typically, the servicing of loans is retained by the originator, who must keep records, collect payments and generate reports-for which they receive a fee that covers the costs of operation. "The beauty of it is the enhancement of risk," Rays said. "It's a tool for modeling a credit union's ALM (asset and liability) portfolio. And why earn 6% from a bank CD when a loan participation can earn 7% or higher with minimal risk?" he asked Interest in loan participations is growing, Rays noted, because he's received call from several state leagues and more and more credit unions every day. Judy Sandberg, president of Callahan Financial Services, said that at a partners meeting held in Hilton Head Island, S.C., recently, it was agreed to form an initiative to broker loan participations. "We want to take some action regarding loan participations," she said. "I'm very excited to be working on the idea." Paragon has learned a lot about packaging loan participations in the last three years, he noted, and he wouldn't advise that credit unions thinking of doing it assume they can take it on themselves. "That's a temptation, but I wouldn't recommend it. It takes expertise to do it well." -caburger@cutimes.com