The ‘Net Seller’ Revenue Leverage

Retaining all the yield from loans is not always the best business decision for credit unions.

Credit unions want revenue, and credit unions that are booking high yielding loans do not want to give up that yield. 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 more advantageous to be a net seller and sell loan participations while retaining servicing

A net seller credit union that sells 90% and retains 10% of its loans is able to leverage its lending capital tenfold to serve more members. Although the credit union gives up loan yield, it increases origination fees tenfold and earns servicing fees on the portion sold. In effect, the servicing fee enables the seller to retain a portion of the yield sold to the buyer. And as the servicer, the seller maintainsthe member relationship. Loan participations spread the seller’s credit risk over more loans. Participations also give the seller a tool to make larger loans and manage loan concentration. Additionally, participations help the industry in that they offer an opportunity for more credit unions to earn income on loans.

To illustrate the effect of what a net seller can leverage, let’s assume 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%, then the credit union nets $300,000 per year in revenue before operating costs. If the origination fees were 1%, then that is another $100,000 in one-time fees.

If the credit union adopts the net seller business model and sells 90% of its loans as participations, then it will be able turn its $10 million portfolio into 1,000 loans of $100,000 each for a total portfolio of $100 million in loans. The credit union’s interest yield remains the same because the credit union is still loaning $10 million. The credit union’s 1% origination fee, however, jumps to $1 million on the total $100 million portfolio. Its 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 more in origination fees and $900,000 in new serving fees.

If the seller operates at only half capacity and makes $50 million in loans, it would still earn $500,000 in origination fees and $450,000 on servicing fees. The loan yield on $5 million, the 10% retained by the seller, is $150,000. Although selling 90% of the loan portfolio results in a $150,000 reduction in loan yield, the servicing fees and increase in origination fees more than make up for it.

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. Relying on the same credit unions to buy participations has worked in the past, but it is important to find new buyers. According to the NCUA, there will be a regulation change that will restrictthe amount of loan participations a credit union can buy from one originator. But even without the regulation change, a credit union can never know 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.

Brian G. Lauer is a partner with the law firm of Messick & Lauer P.C., www.CUSOLaw.com.David Dunn is Certification Manager for the CUSO Unity Xchange, LLC, www.unityxchange.com.
June 2, 2014

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