Booking loans with good yield or giving up yield for more loans.
For some credit unions, it’s a dilemma that plays out in a loan participation transaction where revenue is desired but not at the expense of making sacrifices on yield.
One solution for a credit union with high loan demand is to become a net seller, said Guy Messick, attorney with Messick & Lauer PC in Media, Pa., who has extensive expertise in CUSO startups. The net seller sells loan participations in its loans and retains servicing.
The way it works is a net seller credit union that retains 10% of its loans and sells 90% of the loans is able to leverage its lending capital ten-fold to serve more members, according to Brian Lauer, a partner with Messick & Lauer, and David Dunn, certification manager for Unity Xchange LLC, a CUSO that connects credit unions that want to buy and sell loan participations.
“You can always use loan and hold as a strategy,” Messick said. "If you have good loan demand and credit unions willing to participate with you, can do much more in the way of lending.”
Dunn and Lauer said a credit union that maintains a member business loan portfolio of $10 million and the average loan is $100,000 with a 5% interest rate will generate $500,000 in gross revenue. If the cost of funds is 2%, that is a net of $300,000 per year in revenue before operating costs and the assumption that the origination fees were 1%, so that is $100,000 in one-time fees.
If the credit union adopts the net seller business model and sells loan participations at the 90% level, the credit union will be able to take its $10 million and turn it into 1,000 loans of $100,000 each for a total servicing portfolio of $100 million in loans, according to Dunn and Lauer.
The credit union’s interest yield remains the same as the credit union is still lending $10 million. The origination fees on the $100 million in loans are now $1 million and the servicing fee of 100 basis points on the portion sold to other credit unions is $900,000. Fully leveraged, the net interest in this example would generate $900,000 more in origination fees and $900,000 in new serving fees.
If the seller is only at half capacity and makes $50 million in loans, the origination fees are $500,000, the servicing fees are $450,000, and the loan yield on $5 million (the 10% retained by the seller) is $150,000, Dunn and Lauer explained. So, while the loan yield is reduced by $150,000 as a result of selling 90% of the loan portfolio, that is more than made up by the servicing fees and increase in origination fees.
“If you’re making all of your loans and hold them on the books, technically, the assets are built into the loans for servicing rights,” Lauer said. “But when you sell it off, you’re able to charge that lender for the servicing piece, maximizing your origination from the lender.”
Lauer looks to the mortgage market to compare how the net seller model stacks up. Anecdotally, on the business lending side, yields are much higher, he said. Credit unions might think the yields, are in fact, ideal. However, on the mortgage side, there is not as much of a focus on holding onto yields.
Messick said the NCUA has stated that there will be a regulation change that will restrict the amount of loan participations a credit union can buy from one originator.
“There will be some limitation, but we don’t know what it will be,” Messick said. “If you do have this lending capacity, you don’t want to be cut off because you don’t have enough buyers or because of a regulatory cap.”