In Your Best Interest: An ALM First Podcast
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In Your Best Interest: An ALM First Podcast
Navigating Securitizations in the Credit Union Industry
Discover the transformative world of credit union securitizations with insights from Travis Goodman, a principal at ALM First. Have you ever wondered how the credit union industry navigates the complexities of securitizations? Today, we're diving into the world of securitizations in credit unions with ALM First Principal Travis Goodman. Travis and his team have assisted with more than half of all public industry securitizations, playing a role in 8 of the 13 such transactions that have occurred since June 2017.
We'll explore the journey from pioneering issuances to the strategic balancing act between liquidity and profitability. Travis will also provide an insightful commentary of the regulatory landscape that credit unions must navigate to issue asset-backed securities (ABS). You'll learn about the steps required for both federally and state-chartered institutions and the operational shifts needed for success in this space.
Additionally, we'll tackle the critical topic of managing financial transaction risks, especially within the credit stack, the importance of mitigating these risks with thorough preparation. Tune in to gain comprehensive insights into how credit unions can effectively manage risks, build lasting investor relationships, and thrive in the evolving world of securitizations.
Welcome everyone to the 22nd episode of In your Best Interest, an ALM First podcast, a show that will explore common depository challenges, give you an insider's view of the latest market trends and share stories and insights from industry leaders. I'm your host, mike Ensweiler. Have you ever wondered how the credit union industry navigates the complexities of securitizations? Today we're diving into the topic with Travis Goodman, a principal here at Alen First.
Speaker 1:Travis and his team have assisted with more than half of all credit union securitizations, playing a role in eight of the 13 such transactions that have occurred since June of 2017. We'll explore the journey from pioneering issuances to the Strategic Balancing Act between liquidity and profitability. Travis will also provide an insightful commentary of the regulatory landscape that credit unions must navigate to issue asset-backed securities. You'll learn about the steps required for both federally and state chartered institutions and the operational shifts needed for success in this space. Additionally, we'll tackle the critical topic of managing financial transaction risks. I'm excited to take you on this journey to gain comprehensive insights into how credit unions can effectively manage risks, building lasting investor relationships and thrive in the evolving world of securitizations. Well, thanks for joining us today and welcome to the show Travis.
Speaker 2:Thanks for having me. Mike, appreciate it being here.
Speaker 1:Well, you know, before we get started, you know with the subject at hand, why don't you tell us a fun fact about yourself?
Speaker 2:Mike, you've known me for almost 20 years now maybe a little less than that. I'm sure you have something you'd like to share about me instead.
Speaker 1:I'm not sure what I want to share is probably applicable or appropriate for our audience, so I'm going to give you the softball and let you run with it.
Speaker 2:Sure Thanks, mike, appreciate that. Well, I think the one you probably take the most enjoyment out of is that my previous hobbies that I no longer get to partake in more, which is riding motorcycles, which unfortunately is a thing of the past now for me.
Speaker 1:So your risk-taking is more on the t-ball field these days than on the racetrack, huh.
Speaker 2:Yes, on the flag football field. Yeah, that's right Awesome.
Speaker 1:Well, today we're talking about securitizations and credit unions, and maybe you can just start with a little bit of history of what this has looked like in the industry and kind of where we're at today.
Speaker 2:Yeah, sure, this landscape has evolved a lot over the last couple of years and really I would say the more modern securitization landscape is about five years old. In November of 2019 was the first credit union issuance done by GTE Credit Union and since then we've had 14 transactions. But that timeline has kind of weaved through a couple of different environments, obviously going into COVID in the 2020 years and then coming out of COVID into the post. You know higher rate environment kind of transactions and you know initially when the first couple of deals got done. You know initially when the first couple of deals got done. You know let's call it the GTE and the Unify deals. Gte was the first one that was in many ways kind of a can we even do this transaction and they were the trailblazers that got that done.
Speaker 2:The second deal was very much a profit driven transaction. That transaction, from a Unify perspective, was looking at how many transactions did it take me to get to a similar size in securitization through participation land and that institution at that time was doing a lot of $30 million type transactions. So that meant they had to do 10 transactions to get to the same size of securitization and that's a lot of legal review. That's a lot of negotiation on each transaction, and so they were interested in getting to a place where they didn't have to do 10 legal transaction legal reviews, but they could also make similar money to what they were doing in sales through participation markets.
Speaker 2:As we've come out of 2022, with the rate environment changing very quickly and liquidity drying up, most people shifted at that point to be liquidity-based transactions, and while they wanted to make profit for sure, the primary driver of that transaction was the fact that they needed cash. They were just lending so quickly they needed to convert that loan back into cash so they could keep lending out. And as we've kind of come back into the end of 23 and 24 now, it's kind of gotten to be more balanced. I would say Institutions certainly still want liquidity, but that's not quite the driving factor anymore. Liquidity has kind of come under control a little bit, so there's now more of a balanced approach between I need to make enough money to do this, but I also want to get some balance sheet relief through liquidity.
Speaker 1:And so, as you're evaluating these transactions because, as you mentioned, participations were kind of the mainstay in the industry, for you know, I'm really good at producing this type of loan I have more capacity or I don't have enough capacity on my balance sheet to continue to do it, but I have the engine. So I need an outlet for these things. So there's different pricing mechanisms you mentioned. The legal is certainly a consideration, but you have all the servicing and all those other kinds of things you got to worry about as well. But how big of a transaction do you need? How often do I need to issue to really make securitizations worth my while? Because there's a lot of work on the front end.
Speaker 2:Yeah, oh yeah. It's a long process. Initial transaction is probably six to 12 months, depending upon your desired speed is a big lift. So typically we would say you need to be close to 250 to 300 million dollars to make it make sense. There's a lot of fixed costs that you have to overcome and there's a lot of time and political effort that you have to go through to get to a finish line and be successful. And that's not really the case with participations. Right, you can. You can do transactions easily, quickly, without the entire organization kind of getting involved In securitizations. You kind of have to commit as an organization to go down this path and that means that everybody's kind of in the same boat rowing ahead. If somebody's rowing against the boat, that can really be problematic in this particular type of transaction. So you do need to commit to a pretty big size and having that organizational commitment to go forward.
Speaker 1:And how many? Can I be? One and done. Can I do one transaction and that's all I ever do? Or do I need to be a serial issuer?
Speaker 2:I think ideally you want to be a serial issuer. You know, when you go through this process you're going to be introduced to a bunch of investors on the other side who are going to underwrite you as an originator, and they're doing so because they want to continually come and buy the loans that you produce. If you're one and done, you can do that. But ideally you want to be coming back to market to keep your name in front of everybody. But that doesn't mean that if things change and you decide you don't want to come back to market, that you don't have to. So you can be a one and done, but ideally your intention should be probably more frequent.
Speaker 2:I think probably one of the other pieces that comes through this process and kind of maybe what you're alluding a little bit to this is that for an institution coming to market here, this shouldn't be viewed as the solution. This should be viewed as a solution. It's one of the tools and levers that you have to produce an off-ramp for the widget you create. And if you think about yourself as being kind of a factory and you produce this widget in which you produce car loans, mortgage loans, whatever which you have more than your factory can hold. You've got to find a place to sell it and this is one of those places to sell and there's pros and cons to selling it in this market and certainly as you get bigger, the pros become bigger. But ultimately this is just one of those tools. It's not meant to be the tool.
Speaker 1:So what asset classes? I mean? Autos are obviously pretty big, but are there other asset classes that you can securitize?
Speaker 2:Yeah, absolutely. I think one of the more common ones obviously is car loans, because that's such a predominantly credit union type asset. It's also a very big asset class in securitizable markets. But the reality is, for the majority of the credit union banking world, the assets that we produce are very securitizable. So, first lien, residential mortgage loans are very securitizable. Even more recently, home equity loans are becoming securitizable Again. Credit cards and unsecured loans are very securitizable. Even more recently, home equity loans are becoming securitizable Again. Credit cards and unsecured loans are very securitizable. Even solar loans are securitizable, which is really the bread and butter of most of what we do. I mean, there's obviously some things that credit unions and depositories and banks produce that are inside of that. But that's certainly within there. And even if you're in the multifamily space or the business lending side, that's also very securitizable. So there's definitely an opportunity there. But you know, certain asset classes are bigger and certain asset classes have more preference from an investor perspective, which makes it a little bit easier to get to market and get effective pricing.
Speaker 1:So you said this is a six month kind of plus timeline, so just walk us through. What are the timelines. What does this really look like from a process standpoint?
Speaker 2:Yeah. So, first of all, as part of the process, everyone is going to be involved, and I say everyone, meaning technology operations, legal finance, credit technology everybody's going to have a role to play in this, because you're going to have to convert your organization which is a well-oiled machine in many ways, but something that is recognizable to the capital markets groups, and so there's going to be some modification that's required of your organization. Things like e-contracting and e-vaulting, as an example, is going to be required, or making sure you get perfected interest. There's a variety of those types of challenges that everyone's going to have to face that tries to come to this market, and every group is going to have to do something along the way to get there. So that's why I said earlier that it has to be organization-wide initiative, because if the direction of the credit union or the depository isn't rowing in that direction and somebody has an initiative that keeps getting in the way, your timeline is going to get extended and you're going to burn up a lot of political capital along the way. So that's why I think it takes so long, and the first deal is always going to take the longest, because you've got to get everything built. You've got to rebuild your mousetraps in many ways.
Speaker 2:One question we get a lot in these types of questions is you know I'm very member-friendly. Do I have to stay? Can I stay member-friendly right, or do I have to change all of that? And the short answer is no. You don't have to change and become less member friendly, but you need to document when and how you're going to be member friendly. Are you going to offer skip a pays? When are you going to do so? Is that documented and clear in a policy? That is something that a rating agency can come in and model up as repeatable. So that's probably some of the bigger differences just kind of getting the point where you kind of clearly define how you're going to act and that just takes some time to get up and running. And then you have standardized legal docs as an example as well.
Speaker 1:Are there any unique advantages or disadvantages for credit unions in this asset-backed securities market?
Speaker 2:I think that there are some phenomenal benefits from a credit union perspective. I think first of of all is probably the most important one is our stable liquidity. There's a very big difference between credit union deposits and just about everybody else in the world. Credit union deposits are primarily retail based. They're probably primarily below the insured limit base, which means that they're very sticky. It means that if someone was going to leave, as an example, it's usually because the entire organization is having problems. It's usually because the entire organization is having problems. It's not because one organization decides to just move their money and they go somewhere else Something like you saw with Silicon Valley Bank as an example.
Speaker 2:90% of their depositors were uninsured.
Speaker 2:There were large corporations that had big dollar balances that all they had to do was click a button and move to somebody else.
Speaker 2:In a credit union, it's very much the opposite. Where I have very small balances and a lot of them, we end up getting to the point where it's very difficult for liquidity to move in and out, despite what has felt like, in many ways, liquidity challenges over the last year and a half or so. But we can see very clearly that even despite what feels rocky over the last 18 months still has proven out to be very stable as an overall liquidity source. So that's probably one of the bigger pieces. And the other piece that kind of adds on to that is that when we see challenges and usually in other markets, like recessionary time frames as an example credit unions typically see an increase in savings rates of their depositors, which means that their balances grow and they gain liquidity, whereas most other organizations, especially specialty finance companies, as an example they see their liquidity leave as things get concerning. So when the time gets tough, our liquidity grows, which means that we're more able to withstand liquidity shocks than just about any other organization in the world.
Speaker 1:Interesting. Put your investor hat on now. And so how do credit union asset-backed securities compared to those issued by banks or other financial institutions?
Speaker 2:or other specialty lenders yeah, I think they're for the most part very similar, especially when you're producing a common asset class, right like the underlying asset is a car loan. So most of that's pretty similar. There's some unique differences around what credit unions offer. Typically credit unions offer a little bit longer terms than, say, their banking and specialty finance counterparts. So maybe 60 or 72-month car loans might be common for certain issuers whereas 84-month is common for credit unions. So there's a little bit of difference there.
Speaker 2:Typically credit unions offer that kind of right-in-the-middle prime product it's 730, 737, 20, 715, fico whereas a lot of times specialty finance companies um will either be super prime they'll be way up in that kind of 800 stack, maybe they're captives, as an example, or they're going down in the near prime subprime spaces where there's a lot more return for kind of a you know an investor base to come in and try to get uh, you know profitability. So credit unions operate in that really unique space of that like prime, super prime space and it can really fulfill a very meaningful role of auto lending across the country.
Speaker 1:So I'm going to shift gears on you a little bit. Talk about the regulatory landscape for credit unions, is it you know? Talk about the authority you need to issue these securities. Like what does that whole scene look like?
Speaker 2:Yeah, so from a regulatory perspective, credit unions are permissible for Permitted to issue auto ABS and other ABS products, whether it's mortgage or home equity or anything like that. There, you know, is really what allowed GTE in 2019. There, you know, is really what allowed GTE in 2019. There was some additional rulings that came out that identified that creditors have this permissibility.
Speaker 2:There are still a couple of gray areas in the legal laws and I wouldn't say anything that's gray that would keep you from doing it, or gray in the sense that you might think about gray rulings. But, for example, you are required to retain 5% of your issuance and that may be in an asset class that is not specifically identified as a permissible investment class to credit unions. However, that retention requirement of 5% is incidental to issuing an ABS. So, in discussion with regulators, that's why they're okay with it is because it's in an incidental to the actual act of issuing securitization. But that process of retaining a residual or, you know, a triple b as an example investment isn't specifically outlined in the regs. So, uh, that's just where kind of some. There's some legal grayness from that, but for the most part, um, every regulator would would assume that that falls under the incidental powers component.
Speaker 1:Do I need regulatory approval to be able to do this, or is this something I can just start marching down a path and do?
Speaker 2:As long as you're a federally chartered credit unit, you have permissibility to do it. Now, if you're a state chartered credit unit, you might want to go and make sure you have parity with your state, but if you're federally chartered, you do, and all that NCUA asks you prior to issuance is to notify them 30 days prior to your issuance, and that's not even really a requirement. That's kind of a good faith, kind of practice as to just notification that your intention is to issue a security. Here's what it's going to look like, and then you can move on.
Speaker 1:Does that change my examination procedures at all?
Speaker 2:I think you might get some questions after the fact. We've seen that credit unions that have issued have been asked about what they issued, how it's performing, what the process was like, some of those things. So you should be prepared to be able to answer some questions related to it. It shouldn't be anything that's going to stop you from having a successful exam, nor should it stop you from wanting to issue an ABS deal. But, like everything, you have to have a rationale for why you did something and hopefully you have a plan and strategy as to how it's being used. Just like any tool, whether you're going to be borrowing assets, selling assets or engaging in any type of activity, understanding the why you do something and how you're going to use it is important for any regulatory questions.
Speaker 1:So there's been 14 of these or so at this point. So if I want to get into this, I'm no longer a trailblazer. So there's some precedents set, which I think is a good news if I haven't done this already, and so there's no regulatory challenges or hiccups that I have to necessarily worry about as long as my house is in order, so to speak. So I decided to do this Talk about any operational changes that I might need to implement to support this issuance.
Speaker 2:Yeah, there's a couple of important things that are necessary to be able to move forward with this. First of all, you're going to have to go through a rating agency process, so part of that's going to require you to make some changes, whether it's your documentation or setting up some new procedures, getting e-volting as an example. Some of those things are going to be important to move forward with. But I mean, overall, there is nothing that's stopping you from kind of going into this process, except for the fact that you have to be willing to go through some of the hoops. You also have to probably have a pretty deep bench.
Speaker 2:I would say the participants that have gone through this process have spent some time on the road trying to educate investors as to what credit unions are and why they should be buying their deal, and spending some time on the road trying to educate investors as to what credit unions are and why they should be buying their deal, and spending some time and effort to kind of get the word out a little bit.
Speaker 2:And that means, while they're gone, those executives are not in the office. Someone has to be there steering the ship and making sure that things are still operating correctly. So I think that's probably one piece that has to be done as well. And then I would also say that credit unions, just in general, haven't really looked at secondary marketing from a pricing perspective as closely as they probably should have in most cases, and they define where pricing should be based upon what the guy across the street is offering that may not need to sell. And if you're going to engage in this activity operationally, you need to change what you price. You need to make sure you understand what the end result is going to look like so that when you go into this process you know what your gain or loss is going to look like from day one. Otherwise you might be, you know, kind of painful in terms of what you, what you look like in the end.
Speaker 1:So fine tune my pricing models. Making sure I price for the secondary markets is key. So so far, so good. I'm running a credit union. I'm checking all the boxes. So so far, so good. I'm running a credit union, I'm checking all the boxes. Let's talk about kind of risk management now. What are the primary risks associated with issuing asset-backed securities for credit unions?
Speaker 2:So I think the first thing that you should be concerned with in this process is interest rate risk. Okay, so, whenever you have the intention to sell any asset it doesn't matter if it's auto loans and a securitization, or mortgage loans to Fannie and Freddie you need to make sure that the pipeline of assets you're originating are hedged, from the time that you commit that rate to a borrower to when you sell them to the secondary market, and that's true whether you're selling auto AVS or to Fannie Mae in terms of your mortgage pipeline. So interest rate risk and hedging is the first risk that you need to pay attention to. Once you start getting beyond that, there are other risks that are associated with a transaction. First of all, if you don't complete the transaction, there might be some reputational risk. As an example, if you get to market and all of a sudden car lending as an example if we're doing a car loan deal, all of a sudden, car loans have been performing poorly and investors say, hey, I need a higher rate of return. You might be at the 11th hour and all of a sudden, investors need more spread to come in and buy assets.
Speaker 2:That's not something you can hedge away. There's a risk that's always associated with that. The rating agent can come in and change their rating assessment two weeks before issuance and all of a sudden you've got to restructure your deal and it's no longer quite as profitable as when you initially set the transaction. So there's a variety of those things that are part of this process and they're exemplified because, or exaggerated because, the process takes longer. In a participation transaction, where I can do a deal in 30 days and everything gets knocked out and once I agree to a price, 30 days later I close it. You know, as long as due diligence is fine, that's a pretty seamless process in many ways. But with a deal that takes six months, a lot can change between the time that I issue or decide to go forward and when I actually issue the deal. Sure, okay.
Speaker 1:So so far, so good. Let's talk about kind of the future and where we go from here. What future developments do you foresee in this market that could affect credit unions?
Speaker 2:I think there's a couple of ones, I think maybe. Well, first of all, I think we'll see a bunch of different types of securitizations. You know, what we've been primarily talking about today is what's called 140 for a, which is a kind of semi public kind of issuance. It's not SEC registered but it's pretty much where everybody can buy it, at least the qualified investors can buy it. We've also seen some transactions in what's called 4A2 transactions, which is a private deal, and that's typically a smaller transaction. It's not $300 million in size, maybe it's 100 million, and it's sold to an individual, a single investor, and they buy the entire tranches and they distribute it downstream, maybe to their insurance companies or maybe it's to their asset manager, to certain investors, that kind of stuff, and I think we'll see more and more of those smaller transactions, certainly in the future.
Speaker 2:We've also seen what's called credit link notes and credit risk transfer transactions. Those are also all forms of securitized structured finance products and those are examples of where someone is trying to de-risk a trade. Maybe they're trying to sell the credit risk of a transaction to another investor, maybe they're trying to get risk-based capital relief. There's all kinds of little reasons why people go down these paths and there's little solutions that solve them. So I think you're going to see more of these micro trades for sure going forward, as people are trying to find a specific risk they're going to get rid of.
Speaker 2:I also think you're going to see at some point here, you know, four or five credit unions come together to do a big transaction, and the reason why is because the rating agencies have been relatively punitive on issuers that have single state concentrations and they have been giving higher loss assessments for those types of institutions because there's lack of geographic diversification, and so there's been a tremendous amount of conversations in different circles about bringing four or five credit unions together, or even more from different states, to get geographic diversification.
Speaker 2:I think that's probably unlikely to happen at the small size, but I think, for example, our clients will most likely come together at some point with four or five large issuers who have already issued their own deal, they've already been to the rating agency process, they already know what it's like to get to market and they know they want to keep going forward, and then at that point, I think we'll see them come together in kind of mega deals, if you will, because that gives us a better credit loss assumption by having geographic diversification, and I know that everybody can overcome the hurdle of a rating agency process. Otherwise we're seeing people talk about, you know, a bunch of people putting five and ten million dollars in the trade and that might make sense at some point.
Speaker 1:But the rating agency hurdle is going to be a challenge for those types of trades, I think sure well this been exciting and we are bumping up against the time limit here, so I have two last questions for you, For those that are interested what resources are available for executives and staff to learn more about SFX securities in this process?
Speaker 2:Yeah, I think we've had a couple of different webinars. We've done some roundtables for it. I think those are good places to start. There's certainly been now enough people in these circles that you could probably reach out to the credit unions that have issued their own deals. Just about everyone that I know of has been very open to having those conversations. I think, outside of that, some of our conferences we have topics and related concessions related to these types of transactions. You can learn a little more about them there, I think.
Speaker 1:All right. So final question what else should I have asked you about, or what do you want to leave the audience with?
Speaker 2:Maybe one other risk Not that I'd end on a sour note for sure, but part of the risk of these transactions, beyond some of the things I mentioned earlier is that you know you are especially if you're owning a piece of the transaction that's down in the bottom of the credit stack you're still owning credit risk. So unless you were to sell that piece away and you were to take a vertical slice, you're most likely still retaining some risk in this transaction. That does make it a little bit different than a participation market. So just make sure you do your homework, make sure you understand really what you're getting into. As we said, it's a tool. It's not the tool right, and it's one of those levers that we want to kind of have available to us. But at the same time we want to make sure that it's for the right people and they're doing the right for the right reasons. And if we do that we can kind of figure out how to navigate around all these different risks.
Speaker 1:Awesome. Well, it was very enlightening and it was great having you with us today, travis. Thanks for having me. Mike. Thanks, travis, for joining us today and sharing your insights on the world of credit union securitizations. My takeaways from today are securitizations are a great tool for selling loans and gaining liquidity. A lot of the loans credit unions originate are securitizable from a balance sheet perspective, and that credit unions need to have an organizational commitment to go down this path. At the end of each episode, I'd like to take a moment and let you know about some of the additional resources we have available. We have a robust workshop, conference and webinar schedule, so be sure to visit our website for more details on these, as well as our education hub and our resource center for recorded webinars, articles and more.
Speaker 3:As always, stay safe, stay healthy and thank you for listening to, in your Best Interest, an ALM First podcast. Investment decisions, current and future holdings are subject to risk and past performance has no guarantee of future results. Podcasts should not be copied, distributed, published or reproduced in whole or in part. Information presented herein is for discussion and illustrative purposes only and is not a recommendation or an offer or solicitation to buy or sell any securities.
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