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Meeting Member Demand and Managing Risk

Meeting Member Demand and Managing Risk. Mark DeBree, CFA Director – ALM Services. The Environment. Credit unions have been faced with multiple difficulties over the past few years… Weak loan demand Strong deposit growth Low interest rates. The Environment. Liquidity Total Assets ROA

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Meeting Member Demand and Managing Risk

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  1. Meeting Member Demand and Managing Risk Mark DeBree, CFA Director – ALM Services

  2. The Environment Credit unions have been faced with multiple difficulties over the past few years… • Weak loan demand • Strong deposit growth • Low interest rates

  3. The Environment Liquidity Total Assets ROA Net Worth

  4. The Environment Credit unions had to adapt • Deploy funds or face lower and lower returns However… • Demand for traditional loan products remained weak • Investment returns have been dismal

  5. The Environment Mortgage Lending And…….. Long term investments As a result, we turned to

  6. Mortgage Trends Year-End 2008

  7. Mortgage Trends

  8. Mortgage Trends Mtg Loans & Inv

  9. Mortgage Trends Per NCUA (in Part 741): • In 1996: • Credit Union and Commercial Bank residential Mtgs were in 15-20% range • End of 2010: • Credit Union residential Mtgs were 30.7% of assets • Commercial Bank residential Mtgs were 18.4% of assets

  10. Mortgage Trends Credit union mortgage exposure has increased while bank exposures were up only slightly However… Mortgage loan exposure has declined since 2008 But… Total mortgage exposure (with investments) remained above 40% as of June 2012

  11. Times are Changing New rules and regulations • Concentration risk • Interest Rate Risk • IRR Policy and Programs • ……..And……….

  12. Meeting Expectations Examiners are pushing us • Understand balance sheet exposures • Evaluate our exposures in light of economic expectations • Alter balance sheet compositions based on our exposures and expectations

  13. The Big Question How can credit unions continue to meet member demand for mortgages While……… Adhering to regulatory requirements for managing concentration risk and interest rate risk exposures

  14. Managing Mortgage Exposure Three Primary options: • Continue originating and booking mortgages • Cease originating mortgages • Sell mortgages and retain servicing

  15. Selling Mortgages with Servicing Retained Enables Credit Unions to: • Fulfill Member Loan Demand • Manage Concentration and IRR Exposures • Maintain Member Relationships • Provide Liquidity Source • Capture Origination & Servicing Fees • Servicing portfolios are off-balance sheet assets!

  16. Process of Originating and Selling Loans

  17. Process of Servicing Loans

  18. Selling Mortgages with Servicing Retained Primary Earnings Potential • Origination Fees • Typically 1% of original loan amount • **Median origination fee was $2,537 in 2010 (assuming 10% down payment) and $2,734 (5% down) 2. Servicing Fees • Standard fee is approximately 0.25% of outstanding balance; fee is earned over life of the loan • Addition fees and income items are possible • Late Fees, T&I Float, P&I Float, Prepay Float, etc. **Median origination fee reflect 2010 averages as reported on the Federal Reserve Board website

  19. Selling Mortgages with Servicing Retained Example: 30 Year Mortgage Loan: • Loan Value: $220,000 • Interest Rate: 3.75% • Prepayment Rate: 10% CPR • Servicing Cost: $200 annually • Servicing Income: 0.25% of outstanding balance Earn: • Origination Fees (1% of loan value): $2,200 • Lifetime Servicing Income: $2,185

  20. Earning Potential 5 Loans: Origination Fees: $11,000 Servicing Income: $10,924 10 Loans: Origination Fees: $22,000 Servicing Income: $21,849 50 Loans: Origination Fees: $110,000 Servicing Income: $109,244

  21. Building Servicing Portfolios Servicing loans can be extremely profitable and enhance member relationships But…not without risks • Can be costly • Need economies of scale • Lost interest income • Significantly less interest income • Extremely influenced by prepayments • Portfolios are volatile

  22. Costs of Servicing Loan Servicing is a volume business Build economies of scale • Cost of servicing each loan declines as the number of loans increase • Spreading costs over greater volume

  23. Impact of Economies of Scale Base example Servicing Cost: $200 annually • Servicing Income: $2,185 • Servicing Cost: $225 annually • Servicing income: $1,959 • Down 10.34% • Servicing Cost: $175 annually • Servicing income: $2,411 • Up 10.34%

  24. Economies of Scale 5 Loans: Servicing Cost $200 Origination Fees: $11,000 Servicing Income: $10,924 500 Loans: Servicing Cost $170 Origination Fees: $1,100,000 Servicing Income: $1,227,913

  25. Lost Interest Income Using the same example: 30 Year Mortgage Loan: • Loan Value: $220,000 • Interest Rate: 3.75% • Prepayment Rate: 10% CPR • Servicing Income: $2,185 • Whole Loan Interest Income: $60,554 • Lost interest income: $58,369 or 3.50%

  26. Servicing Portfolio Sensitivity As Prepayments Rise, Servicing Income and Fair Value Fall

  27. Portfolio Volatility Fair Value Falls as rates fall

  28. Portfolio Volatility Servicing Portfolio has negative correction to Mortgage Assets

  29. A Similar Option Loan Participations • Able to help manage mortgage exposure BUT…….. • Originating lender (if FICU) must retain at least 10% of participation loans sold • Participation must without recourse to remove from balance sheet • Ability to sell participations depends on others

  30. In Summary Selective loan sales and servicing portfolios can help credit unions • Fulfill member demands • Manage risk exposures • Maintain direct member relationships • Obtain additional Liquidity • Capture Origination & servicing Fees

  31. In Summary However….while servicing portfolios offer off balance sheet income, they are not without risk • Need economies of scale • Drive down average loan servicing costs • Portfolios can be volatile • Prepayments, interest rate changes • Only provide a small portion of interest income • Earn only 0.25% servicing fee of total interest rate

  32. In Summary Loan participations may be another option for credit unions, but: • Not as effective as loan sales at managing risk • FICUs must retain at least 10% on the balance sheet • Unless participation without recourse, entire balance remains on the balance sheet • Not as reliable as a liquidity source • Ability to manage exposure is limited to others interest in the loans offered for participation

  33. Questions Mark DeBree, CFA Director – ALM Services MDeBree@CatalystCorp.Org 800-442-5763 ext. 7873

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