Desperately seeking spread
Many of you may remember the 1985 cult classic “Desperately Seeking Susan.” In this movie, an unfulfilled New Jersey housewife seeks to break out of her mundane, predictable life and follow a bohemian drifter (Madonna) via the New York personal ads.
Believe it or not, a comparison can be drawn between Madonna’s first major motion picture and the current state of affairs in the credit union space.
Many of you are seeking to break out of your mundane, predictable business practices and diversify. I’m hearing from many credit unions that this “awakening” is a byproduct of concentration issues and the necessity to increase earnings. As of Q1 2017, the industry average ROA was 71 basis points and 85% of the loan book was comprised of auto and mortgage/real-estate.
I think you all know the issues you are facing, but how do you create real solutions? My contention is that many credit unions don’t even know the resources they have at their disposal.
Consider for a moment the funding sources available. Those of you who are not low-income designated have FHLB advances, member deposit listing services and directly placed member funding programs. The other 44% of the industry that has obtained low-income designation has several addition options, including non-member funding programs like underwritten DTC CDs. All of these programs allow you the ability to match fund an asset based upon your own interest rate risk profile. Translation: you can literally compartmentalize spread by utilizing wholesale funding sources to match fund specific durations.
For example, you could utilize DTC issued CDs to create funding anywhere from one month to 10 years in duration. But if you’re stuck in a financial rut, what asset could you pair with it with to exceed the industry average of 71 basis points? The answer is out there and it’s not more auto loans or single-family mortgages. You have to be more creative and open minded.
At CMS for example, we are showing our clients loan participations just like many providers but with a keen eye on diversification. Of course, we can deliver autos and mortgages but that’s not the secret sauce. The real value is in asset classes that provide measured risk with yield enhancement (USDA, motorcycle, manufactured home, secondary capital, etc.).
If you leverage these assets and pair them with some of the funding tools discussed above, you can literally place spread on your balance sheet far in excess of 71 basis points.
The same can be done in fixed income. CMS has created a proprietary Municipal Bond Unit Investment Trust (UIT) yielding approximately 3%. We are showing our clients how to utilize very short dated collateralized mortgage obligations (CMOs) paired with funding to generate 80-100 basis points in spread.
Basically, what I’m saying is that you have options beyond callable agencies and FDIC insured CDs.
You don’t have to be satisfied with the status quo. Your membership deserves the best services that you can provide. Think about those programs you have had on your membership “wish list” that you simply can’t afford due to an anemic ROA. You should be challenging your partners to provide you more value and the ability to widen your spread without taking on too much risk, instead of being satisfied with the same mundane predictable programs that you have been offered for the last 30 years.
Reach out and explore your options because you have more than you think. Your most valuable resource is your membership. The more revenue you create, the more products and services you will be able to provide. Those two things are directly related.
We can no longer simply accept our limitations as an industry. Don’t desperately seek spread, because you have options to satisfy this systemic issue. You just have to be willing to watch a Madonna movie.
