To be sure, financial institutions are reevaluating and tightening all lending standards, which is understandable. While the Federal Reserve stopped its rate hike campaign in September, the board suggested that another increase is expected before the end of the year. Businesses and consumers are likewise treading carefully in the face of persistent inflation.
To summarize, everyone keeps their cards (and cash) near to their jackets. Lenders are bracing themselves as loans continue to outnumber deposits. According to S&P, the aggregate loan-to-deposit ratio, a key measure of liquidity, increased for the third time in a row in March. Credit unions, in particular, are dealing with a difficult lending market.
When commercial banks tighten their lending rules, people traditionally turn to credit unions for loans. According to the Fed’s quarterly Senior Loan Officer Opinion Survey, which was released in May, the majority of the 84 responding banks have tightened criteria across consumer loan categories, including automotive, and will do so for the rest of the year. Because of their ownership structure, credit unions are less vulnerable to market changes than larger banks, allowing them to issue loans during times of economic instability.
According to the Cox Automotive/Moody’s Analytics Vehicle Affordability Index, it would take about ten months for someone earning the national median income to acquire an average new vehicle. According to Kelley Blue Book, the average price of a new automobile is currently over $48,000, with used vehicles costing around $26,000. While affordability difficulties are gradually improving, millions of Americans are still priced out of vehicle ownership; in fact, non-prime consumers are rapidly being priced out of the automotive market entirely.
Equifax and CUNA analysis reported in their June 2023 “Credit Union Auto Lending Monthly Report” revealed that when non-prime borrowers choose a credit union, they save between $5,700 and $11,000 over the life of the loan for a $40,000 automotive loan over 72 months compared to similar borrowers at banks. Lower monthly payments also lead to better payment habits among credit union members.
Credit unions have long held a big portion of the automobile loan market, but according to Experian, captives became the largest stakeholder for the first time in several years in Q1 2023. Credit unions must change their lending approach to secure financial security while servicing their members in order to compete against uncertain consumer demand and an unpredictable economic future.
3 Steps to Mitigate Liquidity Risk
Updating your credit union’s lending strategy can assist you in maintaining stability, increasing ROA, increasing yield, and effectively mitigating liquidity risk. And, with the automobile loan season in full swing and inventory finally showing signs of recovery, the time has come for credit unions to enhance their lending operations.
Liquidity is usually front of mind for credit union leaders, but it becomes much more important in an uncertain economic environment. Follow these measures to guarantee that your financial institution is correctly responding to macroeconomic shifts.
1. Diversify your data
In the Open Lending Benchmark Survey, more than two-thirds of lenders look simply at a borrower’s FICO score and evidence of income, which results in an overly restricted picture of someone’s creditworthiness. To discover suitable borrowers and analyze risk, lenders must look at more than simply FICO ratings.
Lenders should evaluate alternative borrower data, such as mobile phone payments, bank account data, and rental history, to estimate the possibility and severity of default with the greatest precision. This method provides a more accurate picture of a borrower’s track record, allowing you to better evaluate your risk.
Automotive lenders must also examine prior automotive data. Lenders, for example, can examine a single vehicle and estimate what a default might look like after 20 months versus after 30 months at the make and model level. Each situation entails a distinct level of obligation for the lender, which should be considered while pricing the loan.
2. Expand your borrower base.
Non-prime customers are frequently disregarded for auto loan chances. However, lending to this credit sector can be critical to portfolio resilience in an unpredictable economy.
While it may appear that catering to non-prime borrowers is riskier, the contrary is true: Too much reliance on FICO scores and lending only to prime borrowers results in excessive variability and risk. Credit unions should set clear underwriting rules suited to this market in order to build non-prime connections. This strategy, when combined with thorough monitoring of borrowers’ progress, helps ensure that only viable candidates obtain loans.
Expanding your borrower base not only reduces risk, but also allows you to give loans to those who are on the verge of fixing their credit. Borrowers are more likely to return to your credit union for other financial requirements, such as mortgages or business loans, after a relationship is built.
3. Price loans more accurately.
Pricing loans correctly in relation to risk and yield targets may appear to be an apparent strategy to reduce liquidity risk. However, many lenders may fail to assess if they are adapting their pricing and decision-making to the changing market and customer information requirements. A methodical approach to loan pricing is essential. By measuring a lender’s costs and risk levels, lenders can reach a greater level of precision – originating fair, profitable, and less risky car loans with the speed and consistency required in the post-pandemic economy.
It is vital to safeguard liquidity by striking the most profitable balance between subprime and prime loans. To do this, lenders should calculate the ideal number of monthly loans to target, raise the number of subprime loans with higher returns, and decrease the number of prime loans.
Automobile lenders, particularly credit unions, play an unquestionably important role in their communities and for their borrowers. Credit unions must change their strategy to suit the moment, as riskier borrowers are priced out of the car industry and fall outside of the stricter lending requirements. Credit unions can embrace chances and maintain steady growth while retaining their commitment to service by utilizing innovative data and pricing methods.
