How did the credit union get here? And what does the future hold?
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The New Business Of Business Lending
It comes down to the margins, says Mike Schmid, vice president of business services business services at SouthPoint.
He remembers a time when the size of a profitable farming operation was 160 to 240 acres. Profitable operations today have grown so much that SouthPoint can no longer adequately serve them at the scale the farms require.
“Farms need more inventory and more efficiency to get by on smaller margins,” Schmid says. “They used to make so much an acre, but they can’t anymore. So, they need more acres or more cows or more hogs to make up the difference.”
With expansion comes rising costs and increased need. However, the MBL cap limits how much SouthPoint can hold on its balance sheet. Additionally, the credit union is a smaller institution that’s also focused on consumer banking. It isn’t staffed to serve commercial interests as much as its competitors in this space, which include regional and national banks as well as farmer co-ops.
It’s these cooperatives, especially, that have changed how agricultural lending works in SouthPoint’s communities. Farmer co-ops subsidize lines of credit to farms — as low as 1%-2% — if, in return, farms buy products from the co-ops.
For the co-op, that line of credit is a loss leader, much like a 1.99% auto loan might be at a credit union. However, whereas the credit union offers that rate to bring in new members and cross-sell other services, the co-ops offer it knowing farmers must buy their products.
“The co-op is doing what’s best for their business, and we get that,” Schmid says. “They’re not trying to get the line of credit. They’re trying to sell more product. The line of credit is their mechanism for doing so.”
The effect on SouthPoint’s balance sheet is clear. In the first quarter of 2014, the height of ag lending at SouthPoint, loans secured by farmland, loans to finance ag production, and other loans to farmers held a 21.3% share of the credit union’s total loan portfolio. By third quarter 2017, that percentage had fallen to 12.5%.
After its peak in 2014, ag lending at SouthPoint has steadily dipped as a percentage of total loans in the three years since, according to data from Callahan & Associates.
The new reality has forced a paradigm shift at SouthPoint. In response, the credit union is exploring different opportunities, different ways to reduce concentration risk, and different ways to meet the needs of members.
For example, in early 2016, the credit union jumped head-first into a wholly different line of business: indirect auto loans.
An Indirect Boom Town
To say indirect lending at SouthPoint is new isn’t quite accurate. It just wasn’t as successful in the past as it is today.
The credit union has held anywhere from $100,000 to $1.6 million in indirect autos for the past dozen years, but its process for getting these loans was “old school,” says Jay Gostonczik, SouthPoint’s vice president of retail services.
“We relied on dealers to send us applications via fax or email,” he says. “That’s not an expeditious process, and the dealers had already transitioned their systems to be more expeditious.”
In researching the value indirect lending might bring to its membership, SouthPoint discovered approximately 70% of members received financing in the dealership. To meet its members where they were and modernize its indirect machine, the credit union joined the Dealertrack and CU Direct networks.
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For SouthPoint, indirect also is a point of entry into new communities. In 2015, the credit union converted from a federal to state charter and added 10 counties to its field of membership. Indirect lending allows the credit union to build its member base across its new footprint with the aim of eventually building branches in those communities.
“Indirect helps us see if there’s a market for a branch,” Gostonczik says.
But indirect members aren’t like other members — they are looking for an auto loan, not necessarily a new financial institution. For SouthPoint’s indirect expansion strategy to work, the credit union needs to deepen relationships.
The credit union uses a combination of outbound calling and digital communication to contact new members 12 times over the course of their first year. Rather than focus on gaining checking accounts, however, SouthPoint pitches members on the cooperative difference, educates them on its digital channels — specifically e-statements and online bill pay — and promotes its financial wellness services.
“We know better than to try and sell checking accounts,” Gostonczik says. “They didn’t go to the dealership for a checking account. They went to buy a car.”
According to Gostonczik, the credit union is currently successfully cross-selling indirect members at a rate of 10%.
We know better than to try and sell checking accounts. They didn’t go to the dealership for a checking account. They went to buy a car.
Not surprisingly, indirect lending at SouthPoint has spiked exponentially since turning on the spigot. In the fourth quarter of 2015, the credit union held $550,000 in indirect loans. As of third quarter 2017, that figure was nearly $32 million.
With this success, though, comes questions of liquidity.
SouthPoint’s loan-to-share ratio has grown 13 percentage points from first quarter 2015, before the institution’s indirect activities really kicked in, to third quarter 2017, when the loan-to-share ratio reached 96%. To balance this growth, the credit union sold its first pool of indirect participations — a $4 million portfolio — to another Minnesota-based credit union in December 2017.
The leadership teams at the two credit unions had known one another for some time, and the transaction fit the differing needs of both institutions. SouthPoint wanted to offload some loans, and the purchasing credit union wanted to diversify its balance sheet at a lower cost than running an indirect program itself.
The purchasing credit union paid a premium for the pool based on its expected yield above a two-year Treasury note, Gostonczik says. As rates start to rise, the calculations might change, but for now it makes sense.
“You can purchase an investment with that same $4 million,” he says. “But what’s the return?”
As with any participation, knowing and trusting the underwriting standards of the selling institution is paramount. And when it comes to indirect, SouthPoint’s delinquency rates fall well below asset-based peer averages. As of third quarter 2017, the difference was more than 30 basis points.
“We know how we would value that portfolio based on our risk appetite, but for us to get a sense of what the other credit union thinks is like going on a first date and getting to know one another,” Gostonczik says. “If you want to have a healthy partnership you should be fully transparent.”
Now that SouthPoint has its first participation sale under its belt, Gostonczik says he expects to sell $2 million to $4 million each quarter for the foreseeable future. Given the familiarity and comfort between the two institutions, why not?
“They’ve seen our financials over the years and know how conservative we are,” Gostonczik says. “The transaction itself isn’t that hard. It’s the due diligence and making sure the credit union is comfortable with how we underwrite that’s critical.”
Credit unions have made significant gains since the Great Recession started 10 years ago. Third quarter credit union growth trends surged past that of community banks and the overall banking industry. Measures such as loans, shares, capital, and membership have all reached new levels. These gains are all notable and meaningful; however, they are backward-looking. The important question to ask is: Where will credit unions be in the next 10 years? In this issue of Strategy & Performance, learn why now is the time for credit unions to challenge themselves.