Credit unions want revenue and those credit unions that are able to book good yielding loans do not want to give that yield up. But retaining all the yield from loans is not always the best business decision. If a credit union has a high loan demand it is much more advantageous to be a net seller. A “net seller” sells loan participations in its loans and retains servicing.
A net seller credit union that retains 10% of its loans and sells 90% of the loans is able to leverage its lending capital ten-fold to serve more members. While loan yield is given up, the origination fees are increased ten-fold and servicing fees are earned on the portion sold to other credit unions. Another way of looking at the servicing fees is that the selling credit union is retaining a portion of the yield sold to the loan participation buyers. Loan participations spread the seller’s credit risk over more loans and the seller has a tool to make larger loans and manage loan concentration issues. As the servicer, the seller still maintains the member relationship. The industry is better off as more credit unions have an opportunity to earn income on the loan participations.
To see the effect of this leverage by being a net seller, let’s assume that a credit union makes and holds 100 business loans of $100,000 each for total loan portfolio of $10 million with a 5% interest rate. This generates $500,000 in gross revenue. If the cost of funds is 2%, that is a net of $300,000 per year in revenue before operating costs. Also assume that the origination fees were 1% so that is another $100,000 in one-time fees.
If the credit union adopts the net seller business model and sells loan participations at the 90% level, the credit union will be able to take its $10 million and turn it into 1000 loans of $100,000 each for a total portfolio of $100 million in loans. The credit union’s interest yield remains the same as the credit union is still loaning $10 million. The credit union’s origination fees on the $100 million in loans is now $1 million and the servicing fee of 100 basis points on the portion sold to other credit unions is $900,000. Fully leveraged, the net interest model in this example would generate $900,000 million more in origination fees and $900,000 in new serving fees.
If the seller is only at half capacity and makes $50 million in loans, the origination fees are $500,000, the servicing fees are $450,000, and the loan yield on $5 million (the 10% retained by the seller) is $150,000. So while the loan yield is reduced by $150,000 as a result of selling 90% of the loan portfolio, that is more than made up by the servicing fees and increase in origination fees.
The keys to being a net seller is to have a robust loan demand, a good and scalable loan origination and servicing function and an efficient means to find loan participation buyers and complete the transactions. While relying upon the same credit unions to buy your loan participations had worked in the past, it is important to find the means to find new buyers. The NCUA has stated that there will be a regulation change that will restrict the amount of loan participations a credit union can buy from one originator and even without a regulation change one never knows when buyers no longer can or want to buy loan participations. Participation in services that efficiently locate potential buyers and streamline the loan participation sale function is essential to making sure your credit union has the pipeline to execute the net seller model.
David Dunn is Certification Manager for the CUSO Unity Xchange, LLC, www.unitxchange.com.
Brian Lauer is partner with the law firm of Messick & Lauer P.C., www.CUSOLaw.com