When the National Credit Union Administration (NCUA) released a proposal in June 2017 to permit federal credit unions to securitize loans, the auto industry took notice.
But no credit union has taken action. Yet.
“My initial reaction to the rule is that it won’t have much reach to credit unions outside the largest credit unions,” Curt Long, chief economist and vice president of research at the National Association of Federally Insured Credit Unions (NAFCU), told Auto Finance News. “I think it might help for those credit unions that take advantage; it can set up some resources to grow loans.”
The largest credit unions in terms of auto portfolio size, as of yearend 2016, are Navy Federal Credit Union with $11.5 billion in outstandings, Security Service Federal Credit Union with $5.4 billion in outstandings, and The Golden 1 Credit Union and Alaska USA Federal Credit Union each with $3.8 billion in oustandings, according to Big Wheels Auto Finance 2017.
“Navy Federal is aware of [the ruling], although we don’t have a position yet,” a spokesman for the credit union told AFN.
Credit unions have a “substantial marketshare in auto lending,” the NCUA reported in its proposed rule, “and auto loans are the credit unions’ fastest growing and most widely offered product.”
Banks in the auto lending space controlled 32.9% of total financing in the third quarter of 2017, down from a 35.1% marketshare during the same period the year prior, according to an Experian Automotive report. This pullback proved beneficial to captives and credit unions, as captives grew their share of total financing by 150 basis points to 29.8%, and credit unions added 140 basis points to reach 21% marketshare.
Currently, the most common way credit unions fund new loan originations is by reallocating retained earnings. By creating a clear path for credit unions to tap into this growing ABS market, the NCUA is allowing them to free up capital for additional lending and take on even more auto loans. Year to date, lenders have issued $8.7 billion in auto asset-backed securities as of Jan. 26, up 55% from the same period last year, according to report from JPMorgan Securities.
However, even though the tides have turned — allowing credit unions to securitize — there are still a few more hurdles credit unions need to clear.
Will Credit Unions Take Advantage?
Securitization might not be an optimal choice for credit unions, which are member-owned. “Credit unions also want to be more flexible with their members to allow them to modify loans, and that doesn’t fit into bond issuing,” John Toohig, managing director of whole loans at financial services firm Raymond James Financial, told AFN.
But credit unions have still been curious, he said, adding those institutions have been inquiring about the time and resources required for issuing transactions and whether it’s a worthwhile endeavor. “It’s still exploratory,” he said.
Rating agencies may also face challenges, as no credit union has issued a securitization before, prompting uncertainty around how well credit unions and their securitized pools will perform when put under the microscope.
Moody’s Investors Service, however, plans to benchmark the quality of credit unions’ historical data and historical performance volatility against their auto ABS peers, the company said in a report. “Other comparative factors that help establish appropriate loss-protection levels are a credit union’s ABS collateral pool and managed portfolio characteristics, structural features including triggers, transaction governance and oversight, and the alignment of interest with those of auto ABS investors,” according to a Moody’s report.
Meanwhile, S&P Global would view credit unions similarly to the way it sees banks and auto captives, Amy Martin, S&P’s senior director of structured finance, told AFN. However, sometimes credit unions have a geographic concentration, so if the local economy was doing poorly in some way, it could reflect on credit union members and thus the credit union’s portfolio, she said. The rating agency may have to evaluate for that specific risk.
The impact for the rating agencies themselves would be access to a more thorough review of the auto finance market, she said. Chris O’Connell, senior vice president of U.S. and European markets for global structured finance at DBRS, also said it would benefit rating agencies.
“I think we’d be excited to see a new market player from a different channel,” he said. “Normally we see banks, captive finance companies, and finance companies, so [credit unions] would be good for the market.”
Costs vs. Benefits
The effort it takes to securitize is “substantial” and can cost upward of $1 million, which is partly what makes it unfeasible for smaller credit unions, Raymond James’ Toohig said.
There is also a “complex decision tree” that credit unions face when considering a securitization, according to Stuart Litwin, a partner, and co-head of the structured finance practice at Mayer Brown LLP. There are too many variables to consider for a credit union, including cost, the uncertainty about what would happen to a securitization if the NCUA took over for a bankrupted credit union, and what infrastructure the credit union has in place for the disclosure of asset-level data.
The disclosure of asset-level data is a particularly notable issue, according to Litwin. In August 2014, the Securities and Exchange Commission adopted final rules under Regulation AB — a comprehensive body of regulations for asset-backed securities. Starting in November 2016, lenders issuing public auto ABS transactions were required to disclose loan-level data about borrowers and to update it on a regular basis. More than a year into this reporting process, investors are starting to see initial findings such as average APR, payment-to-income ratios, credit score,
and loan-to-value ratios of consumers in the pool.
Asset-level data requires implementation of specific systems to accurately share the information, Litwin said. Auto finance companies knew these rules were coming out, so they were able to plan to upgrade their systems. Credit unions “won’t need to take as long” — as they can model systems off auto lenders — but the system upgrades will still take them some time, he added.
If, or when, a large credit union securitizes, there could be systems-vendors who can help prepare the institution, Litwin said. Through the process, the vendor might be able to make the cost of the process cheaper over time, opening the door for smaller credit unions to issue securitizations at a lower price. Thus, there could eventually be a viable, affordable route for smaller credit unions to issue transactions moving forward, according to Litwin.
However, it is still unclear when the first credit union will securitize — or which ones might be interested. And it’s not likely any players will jump into the capital market until regulatory guidance is provided.
“I think as an industry, we are still looking for some [regulatory] guidance,” NAFCU’s Long said. “There’s still some uncertainty,” but guidance is expected “imminently,” he added.
It will take “the right” credit union to issue a securitization, Toohig said, adding that he would not be surprised if one of the top credit unions gets on board first. “But we’ll have to wait and see.”