AUSTIN, Texas - Your members balk at paying any more on auto loans. The yield on two-year Treasuries is modest, to put it politely. But the board wants to boost ROA targets. Today's reality is packed with "incredible challenges," says Emily Hollis, president of ALM First Financial Advisors. Among other...
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AUSTIN, Texas – Your members balk at paying any more on auto loans. The yield on two-year Treasuries is modest, to put it politely. But the board wants to boost ROA targets. Today’s reality is packed with “incredible challenges,” says Emily Hollis, president of ALM First Financial Advisors. Among other things, she’s concerned boards may harbor unrealistic expectations. “The biggest challenge credit unions have, not only in investments but in total balance sheet management, is the flat yield curve,” Hollis says. “The two-year Treasury, for instance, which is the index used for car loans, is yielding 4.24 while the 10-year is yielding 4.48. “That’s only a 24 basis point pickup for going eight years longer. I think it presents some incredible challenges for all financial institutions. What we’re seeing out there is that car loan rates are stubborn. They are just not moving up with short-term rates. A little over two years ago we saw the two-year at 1%. So we’ve seen over a 300-basis point rise, but car loan rates haven’t moved up 300 basis points.” On the other hand, Hollis continues, certificate rates have moved up 300 basis points, creating great pressure to compete for short-term deposits while the long-term end is actually lower than in 2003. “Credit unions aren’t able to make a whole lot of mortgage loans and have a decent spread. Even those credit unions that stayed short in 2003, knowing that rates would rise, don’t get any incremental yield if they go longer,” she notes. “They have to continue to stay short, unless they believe rates are going to fall – and we don’t believe that. So it’s a real challenge for credit unions to make money.” She agrees it’s especially taxing for small credit unions that find it difficult to carry on-staff a wide range of expertise. Car loan rates, she figures, should be 300 basis points higher than they were two years ago. But that would mean an auto loan that was 3.50 or 4% would be perhaps 7% if the loan rate had moved in line with the spread credit unions saw in 2003. “It’s kind of gone from bad to worse,” Hollis declares. Isn’t there some good news? Well, yes, she suggests. A lot of credit unions aren’t paying anything on share draft accounts. So if the money is invested at 4%, there is a spread. “We are investment managers and balance sheet managers here. But we used to tout a credit union should go out and make more loans, and by making more loans you’d make more money. Usually that’s the case. “But right now it’s kind of the reverse,” Hollis says. “When you consider the labor and everything involved in making a car loan at 5% or even a little bit higher, we can easily get an investment close to that with the same kind of risk.” What’s a credit union CEO or loan manager to do, beyond stocking up on over-the-counter painkillers? The first answer, Hollis says, may be simplistic for large credit unions. But you need to be aware of where you are, and know how the rate on any two-year investment stacks up against their rate for car loans. If you’re posting car loan rates at 4.90%, you probably need to increase them. If that slows down car loan traffic, it’s okay. Another step is to educate board members that there’s nothing wrong with going through rough times and accepting the fact the credit union is going to make perhaps 60 basis points this year instead of 100. The worst thing that can happen, Hollis continues, is for board members to insist the credit union needs to make more money without understanding making money will mean shouldering new risks. “A lot of times it’s an educational process,” Hollis says “You go to the board members and say, `You want me to make 100 basis points. If we are trying to target this amount of bottom line, this is the risk we are taking.’ “Most of the time, if board members fully understand and have a low tolerance for risk, at that point they’ll say, `Let’s just wait it out.’” Based on the incredibly tough rate environment during the past five years, Hollis believes sometimes it’s not prudent for board members to make ROA a target for success. The problem with doing that, she indicates, is it forces management to take undue risks or do something the board members might not really have in mind. The industry is evolving away from focusing on ROA and moving toward total balance sheet management. What about member attitudes? Are they also changing? Hollis cites studies such as the September data which showed consumer confidence as low as it’s been in 15 years. “This can be related to (Hurricane) Katrina,” she suggests. “People are depressed. However, as one economist pointed out, American can be depressed and still keep spending money. Retail and motor vehicle sales are down, but home sales are still strong. Home prices are making people feel wealthy.” -
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