<p>After cranking out a record $47.4 billion in first mortgage loans in 2001 (see table), credit union mortgage lenders will see slower mortgage activity as sated housing demand and higher interest rates affect the mortgage market in 2002. So what will slower real estate lending mean for credit union lending activity and what will be the composition of the loan portfolio in the coming year? Credit union data from CUNA's economics and statistics department indicates that first-mortgage lending activity remained robust in the 1st quarter of 2002, as loans in the pipeline from November and December were closed in early 2002. Fixed-rate first mortgages grew 4.1% in the first three months of this year versus 2.4% in 1st quarter 2001. This lending product is now the largest category of a typical credit union's loan portfolio, making up 21% of all loans. Adjustable-rate first mortgages grew faster than any other credit union loan product in the 1st quarter, increasing 5%, versus a 0.4% decline for the comparable period last year. This was to be expected for two reasons. First, the very steep yield curve has made short-term adjustable rates attractive versus the much higher long-term fixed rates. The lower interest rate and corresponding lower monthly payments are apparently sufficient to offset the interest rate risk assumed by the adjustable rate mortgage borrower. Second, the recent run up in home prices over the last 5 years, and specifically over the last year, has lowered housing affordability for many prospective homebuyers. Since 1996, housing prices increased 36%, according to the Office of Federal Housing Enterprise Oversight, the fastest 5-year pace in American history. Last year home prices rose 9%. After adjusting for inflation of only 1.6%, this was the fastest real home price appreciation in history. Lower monthly payments on ARMs -for the first year or so anyways – makes homes that were previously out of reach with conventional fixed-rate loans now affordable. ARMs will continue to be popular for the rest of 2002 especially if fixed-rate mortgage interest rates head higher. In fact, this could be a banner year for the adjustable-rate mortgage market if the Federal Reserve keeps short-term market interest rates low. With the record level of originations in 2001, how much are credit unions keeping in portfolio and how much are they selling off into the secondary market? According to data released by the National Credit Union Administration, 35.6% of all loans originated last year were sold into the secondary market or roughly $16.9 billion (see table). This is the highest percentage sold into the secondary market since 1993, when 47% of all originations were sold off. Currently only one in five credit union mortgage lenders is active in the secondary mortgage market, with most credit unions willing to accept an ever larger portfolio of mortgage loans. This strategy may have detrimental consequences if long-term interest rates rise significantly over the next year pushing down the value of the mortgage portfolio. What's the direction for long-term interest rates? Long-term interest rates are expected to rise slowly over the next year as nascent signs of inflation start to build. The Federal Reserve's massive monetary stimulus, higher energy prices, an expanding economy and fiscal budget deficits will mean higher inflation and therefore higher long-term interest rates. Even though the forecast is for slower mortgage lending activity over the next few quarters, it will remain somewhat strong and better than most other credit union lending products. First quarter numbers show credit union new auto, unsecured and credit card loan balances declined 0.7, 2.5 and 6.6%, respectively. Used auto loan balances grew a modest 0.5%. If it weren't for real estate based loan growth, credit unions would have experienced negative loan growth in the first quarter of this year. Since 1995, credit unions' market share of the entire mortgage market has increased from 1.9% to 2.5% today, a 32% increase in market share. During that same time period, home mortgage balances grew 60% for the entire mortgage market, while credit union mortgage balances increased 104%. Credit unions have made great inroads into the mortgage market because larger mortgage departments are bringing about economies of scale that allow for very competitive loans rates. Also, credit union mortgage lending expertise has increased significantly over the last decade. With the refinance boom apparently over, credit unions should be hesitant about slashing staff in the mortgage department. Even though the bottom line may look better in the short-run, the harm to long-term member relations may reduce future earnings. Moreover, during slower economic times, it is not so much what happens to the average financial institution that matters, but what happens to the differences between financial institutions. The refinance slowdown can present a real opportunity to steal market share away from less competitive rivals who are behaving like scared turtles and retrenching. Therefore, use the mortgage lending slowdown as an opportunity to be aggressive and show your membership what you have to offer. Since consumer lending is forecasted to remain weak for the next year, the near term future for credit union lending activity appears to be real estate loan based.</p>