Why Deliberate Pricing & Efficiency Are Key to Future Lending

Today’s lending environment is unique, with rates rising more quickly than many of us have experienced in our careers and inflation at 40-year highs. At the same time, longer-term trends such as automation and artificial intelligence are helping lenders use technology to make better credit decisions more efficiently. This specific moment in time presents both challenges and opportunities for credit union leaders and the members they serve.

A Full Throttle Challenge

One of the common challenges we’ve seen since COVID began is institutions opening all their lending valves and waiting for production. For much of the past two years, liquidity has been high across the industry and consumer borrowing was down. This caused many credit unions to chase consumer loans, and subsequently loan yields, down to the floor.

After the Fed began raising rates in March 2022, those low loan rates began garnering more attention from consumers. With their lending throttles fully open, some institutions filled up their balance sheets quickly with below market rate loans. The lending volumes increased so quickly, and institutions were so hungry for loans, that some leaders may not have even recognized they were mispricing assets until after the fact. This creates a very challenging dynamic in the short run, especially if the institution is required to sell those mispriced assets at a loss to generate liquidity.

Trends in Mortgages, Autos and Unsecured Loans

At the beginning of 2022, first mortgages were the first to be impacted when the long end of the yield curve shot up and the market began to see the signs of the rising rate environment to come. A lot of institutions got stuck with mispriced first mortgages on their balance sheets early in the year and pivoted to variable rate home equity lines of credit as the mortgage refinance boom ended. HELOCs can benefit consumers as they don’t have to disrupt the great low rate on their first mortgage and can affordably access the equity needed to make home improvements. From a lender’s perspective, HELOCs are attractive because of their variable rates and the substantial amount of equity available due to several years of strong home value growth.

In the auto lending space, we’ve seen some big swings in risk-adjusted return on equity. Traditionally, ROE for autos was in the 15% range prior to COVID. During the pandemic, when there was scarcity, this was down to 10-11%. Now that there is a scarcity of liquidity, the ratio has moved in the other direction in the range of 16-18% to attract investors into the auto space. Historically high rate volatility has had a big impact on auto portfolios. For example, a loan priced at 1.99% in the old environment is now below a 2-year Treasury note at 3.00%. We think auto rates need to increase to make sense on credit union balance sheets.