In the late aughts, Shoreline Credit Union ($91.8M, Two Rivers, WI) was riding a rising wave of indirect lending. Loans were growing. So were yields. Business was good.

The Badger State cooperative had even co-founded an indirect lending CUSO, Financial Institution Lending Options, in 2007 with operations in Wisconsin, Illinois, and Minnesota.

Between 2007 and 2013, the credit union’s indirect lending portfolio jumped from $3.2 million to nearly $36 million, or 40% of its total loan portfolio. Portfolio yields were good, too, certainly higher than that of other portfolio products.

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However, in 2013 things changed at Shoreline. It sold its stake in its CUSO, and since mid-2016, Shoreline has dropped nearly $10 million in indirect loans from its balance sheet.

Why?

In this Q&A, credit union CEO and CFO Nathan Grossenbach talks about his institution’s decision to divest from indirect, how he gained institutional buy-in, and the pain points in taking a closer look at operations.

What is Shoreline’s long-term goal for indirect lending?

Nathan Grossenbach: We want to reduce indirect loans from 50% of our portfolio to 0% in seven years — by 2020. It’s a tough target, yes. It’s aggressive and requires a heavy amount of focus, but it is attainable.

Why are you leaving the indirect lending space?

NG: Partly profits, partly service. Mostly, originating indirect loans to “members” didn’t meet our vision of a community-centered credit union. With so many financial institutions merging in our area, we wanted to ensure we were deploying our funds to support our members and our community.

Shoreline recorded huge growth in the early 2010s from indirect lending. How did you gain institutional buy-in to leave both the CUSO and the indirect lending space?

NG: The numbers played a large role. Particularly over the past year, investment yields surpassed indirect yields considerably and had near-zero risk. This wasn’t necessarily the case in 2013, but even then, indirect loans came with extra cost but not extra business. Less than 5% of indirect borrowers had more than a $5 primary share, we had carrying costs from empty relationships post loan closing, and nearly 25% paid off their loan after three months, which meant Shoreline ate the majority of the indirect fee and dealer reserve fee.

Add in charge-offs and servicing delinquent loans, and we were looking at direct costs that crushed that yield to around 0.20% to 0.30%. We even found there were many cases where we would turn down a member internally only to end up with their FILO loan at a lower yield plus a dealer reserve fee.

What were some challenges in changing how the organization operated?

NG: We had to offset the loss of income by creating a leaner institution. In many ways, we had to downsize our expense structure to where we were before we started the CUSO, while also considering the increased cost of regulation and compensation. Indirect lending covered up a lot of excess spending and uncontrolled growth. The regulators first opened our eyes to our reliance on indirect lending, which helped our board to have an open mind to asset and loan volume loss.

I urge any credit union with a heavy reliance on indirect lending to look past the growth in assets, loans, and membership to determine if they are truly using the credit union’s funds in the best manner.

We have to turn a profit, so we can’t completely remove indirect. But we would much rather originate all our loans to our chartered communities.

How has Shoreline replaced the income from indirect loans on its balance sheet?

NG: Our increase in income is mainly due to increases in investment income. Fee income is up, but it is more or less due to a reporting change for debit card interchange. We’ve had to aggressively look at every aspect of our business. Reducing excess staff and turning those positions into revenue centers, automating many of our features, including ACH processing and branch structure.

Make no mistake, we cut expenses and monitor our income until it gets too low, and then participate a smaller portion of indirect loans. As much as want to go cold turkey, it would be impossible. Slowly, we will roll off all the indirect loans as we find new avenue streams and continue to let our core loan growth, specifically in-house mortgages and consumer loans, of 20% or greater over the past three years replace the lost income from indirect sources. There is light at the end of the tunnel.

What does leaving the indirect space provide the credit union from a cooperative sense?

NG: We have to turn a profit, so we can’t completely remove indirect. But we would much rather originate all our loans to our chartered communities. We’d much rather turn the dealer reserve fee into increased dividends paid out to our members. We consistently have the highest deposit rates in the area, which is a tribute to our efforts.

We have a strong internal lending team that is keeping pace from an income perspective with the loss of indirect loans. Per month loan originations have increased from $200,000 on a good month to nearly $1 million per month, with fewer lenders. This is the true success story, partly born out of necessity but also a great example of what kind of impact the right people can have on your institution.

Would you ever turn on the indirect engine again?

NG: Engine, no. We’re doing our best to break the habit, but we might have to go back to the well to stay afloat and sane.

This interview has been edited and condensed.

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