As credit union executives develop lending strategies for the future, they do so in an uncertain environment. There still are opportunities to be found in first mortgages and auto lending.

Although most credit unions avoided the subprime mortgage debacle, the effects of the crisis will linger throughout 2008 and into 2009 with tighter credit, higher delinquencies and charge-offs—even the possibility of a recession.

One essential element in strategic planning is examining how lending has changed. Change is an evolutionary process that's difficult to calibrate, says Dave Colby, chief economist for CUNA Mutual Group, Madison, Wis. "We don't notice change because it happens gradually. Did you add risk-based lending, for example, or did you add a distribution channel? Are you primarily an auto lender?"

Many people are surprised to learn that auto loans no longer dominate credit union loan portfolios. Real estate loans made up 52% of all credit union loans outstanding as of January 2008, according to CUNA estimates. New- and used-auto loans comprised 33%.

By exploring credit union changes, the strategic planning team is receptive to change and becomes more effective, Colby says. "This opens up peoples eyes and creates a good discussion and future strategies. Staff become more open to change.

"In terms of lending strategies, examine your portfolio for changes in the distribution of loans, and the age and demographics of members--especially borrowers," he adds. "Who are your borrowers, how have they changed, and most important, who will they be?"

One change facing $487 million-asset Tennessee Valley Federal Credit Union, Chattanooga, is growing expectations of indirect lending, says Carla Creagh, vice president of operations and lending. "Dealers want answers right away," she says.

Dealers give loans to the first lender to provide approval to keep buyers from walking off the car lot, she adds. "We have 100 dealers in our indirect program, and we work on Saturdays and holidays if the dealers do."

Persuading indirect members to buy other products and services is the "biggest challenge we face," Creagh says. The credit union has achieved some success in this area by giving employees sales goals and holding them accountable.

One common planning mistake is spending excessive time on tactics instead of strategy, says Dan Green, executive vice president/chief operating officer for Prime Alliance Solutions, Tukwila, Wash. "We think tactically: What are our products? What technology are we using? Who are our providers? Instead, we should focus on strategy: Who are our members? What type of housing do they need? What are the challenges our members face?"

Many credit unions also focus too heavily on rates, Green says. "We should focus on the fact that people will always buy homes, even during downturns. First-time home buyers exist in every rate environment, as do corporate relocation buyers."

Economic challenges

Narrowing the focus to credit union lending, challenges will be "managing credit quality, cash flow pressures, and collateral values," says Colby. Housing prices will continue to recede in 2008 and 2009, creating a "strong potential for collateral impairment." As a result, "borrowers' ability to repay becomes even more dominant in the decisioning process."

For Tennessee Valley Federal and other credit unions, the challenge is to foster loan growth while the economy slows. Creagh predicts her credit union's loan growth will fall from a robust 16.7% during 2007 to 6% in 2008. "In 2007, our home equity loan growth was the highest we've had in years, and we had a large amount of indirect lending, averaging $7 million a month."

America's Federal Credit Union's lending challenge this year is to rebalance its auto loan portfolio to get "a better mix of indirect to direct," says Diane Branson, executive vice president and chief lending officer for the $251 million-asset, Fort Lewis, Wash., institution.

"Currently, we have 75% indirect to 25% direct, and we'd like it to be 60% to 40%," she says. "We have more control over direct in terms of rate, acquisition, and long-term relationships."

America's Federal, which serves active and retired military personnel and their families, has 63% of its loan portfolio in new- and used-vehicle loans. Among its challenges are reducing loan processing time and costs, and centralizing approvals at one branch.

Despite such challenges, and the prospect of declining auto loan margins and increased competition, it's critical to stay in the market, says Tony Boutelle, CEO of CUDL, Rancho Cucamonga, Calif. "You have to make loans, or you need a replacement. Is it reasonable to replace auto loans with member business loans?"

Pulling out of auto lending during lean times would make it difficult to return when times are better, Boutelle says. Doing so would "show inconsistency to dealers," making it hard to get back in. He notes roughly 80% of auto financing happens at dealerships.

Boutelle predicts more than 16 million new cars and 40 million used cars will be sold in 2008—about the same annual sales pace as the previous five years. "The challenge is to get more of a pie that's not growing."

Lending opportunities

Even though some see a bleak lending outlook, others see opportunities for loan growth. America's Credit Union is developing programs to serve more military members who have low credit scores. The credit union uses Lender's Protection, a CUNA Mutual Group product that insures against auto loan losses. "It allows us to serve our near-prime members," Branson says.

The "military advantage loan" combines an auto loan and a Visa credit card for soldiers. The rate and payment are affordable, as if they were purchased at a branch or at a dealer. A "starter Visa" consists of a $500-limit credit card for soldiers on active duty, with no waiting time if they have direct deposit. Applicants can pick up the card on the same day they apply.

Credit unions searching for ways to reach young members can learn from America's Credit Union. "Use venues young people use, such as Web sites or podcasts," advises Branson. "We should be convenient. We need to serve young members who want things instantly."

Branson believes there will be a "repositioning of the economy," which will change the products members want. "It will be a good time to buy a house."

Green agrees 2008 will be a good year for mortgage lending—despite problems in the housing market. "About 10% of the consumers who took out subprime loans could have qualified for conventional loans," he says. "This is an opportunity for credit unions to get these people into conventional loans since there will be $600 billion in refinancings in 2008."

Consumers are learning tough lessons following the subprime debacle, Green says. One is they need mortgage lenders they can trust—professionals who will help them understand the difference between an affordable mortgage and a sustainable mortgage. An affordable mortgage is one the consumer can afford today. A sustainable mortgage is one a consumer can afford for years to come, even during economic downturns.

Colby concurs first mortgages offer the best potential for loan growth. He suggests approaching members who have high equity in their homes and showing them how to reduce maturities with a lower loan rate from the credit union. "Be flexible and creative, but don't stray from the fundamentals of good underwriting. Credit scores aren't as good a benchmark as they once were. What really matters is the ability to make payments."

Credit unions have been criticized in some quarters for being overly cautious and risk-averse. With the overall credit union net worth ratio at 11.5%, there's sufficient capital to take prudent risks. "We tend to be very conservative as a movement in our underwriting," says Colby. "Risk-based lending is a good strategy. Equal access to credit doesn't mean everybody pays the same for credit."

Boutelle believes credit unions should branch into nonprime car loans. "Finance companies are making car loans to C, D, and F-paper members. Credit unions need to take more calculated risks."

When credit unions take risks in the auto lending market, they have a competitive advantage banks lack. "The credit union has an affinity relationship the bank doesn't have," Boutelle says. "The credit union will send members back to the dealer for repeat business. The bank won't do that."

Credit unions might be expecting too much from indirect relationships, he adds. If credit unions can cross-sell products to 10% to 15% of new members, they're doing well. "Remember, people go to dealers for cars and to credit unions for financial services. When they get loans with their cars, additional services are the last thing they're interested in."

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