Increased loan growth and stagnating share growth has resulted in the highest loan-to-share ratios in several years. Callahan and Associates reported recently that the number of credit unions with a loan-to-share ratio over 100 percent increased from 350 credit unions in 2003 to 458 credit unions in 2004. Overall loan-to-share ratios for the industry in 2004 ended at 74.4 percent, up from 71.1 percent in 2003. Loan growth continues to drive the tightening with 10.4 percent growth in 2004 versus growth in shares of only 5.4 percent.
Both real estate and auto loans fueled the fire with increases of 14.9 percent and 7.8 percent respectively. The success credit unions have experienced recently in indirect auto loans – over 50 percent of credit unions over $50 million in assets have made indirect loans – is a major factor behind the growth. In fact, indirect lending for credit unions after second quarter last year totaled over $45 billion.
As credit unions experience this tightening in liquidity they are faced with many options to alleviate some of that pressure from borrowing funds to selling participations to other credit unions or transacting whole loan sales with secondary market investors. Credit unions can borrow funds or sell participations or transact whole loan sales to manage their liquidity while protecting their balance sheet. With recent focus on SFAS 140 and true-sale accounting, credit unions need to consider several factors to ensure moving loans off of their balance sheet. Are these factors the same for both whole-loan sales and participations? The answer is yes.
As with any transfer of assets with continuing involvement by the credit union, the transaction needs to be evaluated under SFAS 140 to determine whether or not it qualifies for sale accounting treatment. If it does, the credit union can de-recognize the loan assets and record a gain or loss on sale.
The gain on sale (or loss) calculation is a function of the premium, or discount, paid for the loans versus the book value plus a fair value of the servicing asset (in a servicing- retained transaction). Although indirect lending can provide access to new loans for credit unions, indirect programs, whether conducted by the credit union or a third party, can increase the book value of a loan due to the high cost of acquisition. Dealer reserves, which often run between 1 percent to 3 percent of the loan, must be realized at the time of the sale and cannot be amortized for the life of the loan. The net result is a lower gain on sale, which bears consideration.
In addition to the gain on sale calculation, the credit union will be able to reduce loan loss reserve allowances in proportion to the size of the sale, assuming that the credit quality of the loans in the sale is of the same caliber of the overall portfolio. In Charlie Mac's unique whole loan sale structures where credit unions get paid triple AAA pricing for their loans, a credit enhanced fund on the back end much like an asset-backed securitization is used. In these cases, the credit union would debit restricted cash for the amount in the fund and credit cash.
Having a reliable source of liquidity in place is imperative for credit unions as liquidity continues to tighten. Knowing the accounting considerations in advance will make the loan sale process more manageable. Credit unions may also want to consider that when liquidity tightens severely, the choices for buyers may tighten as well. Identifying your options ahead of time is a practical way to continue increasing loan volume in a tightening liquidity cycle.
For more information about Charlie Mac, contact your corporate credit union investment representative.
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