Imperfect Credit, Perfect Opportunity

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SCOTTSDALE, Ariz.-Credit unions will have to fine tune risk-based lending in 2011, because loan growth opportunity is with less-than-perfect paper.

Mike Kohl, CEO of Kohl Advisory Group, is another industry analyst who sees significant growth potential in lower-quality credit-but insists that if credit unions go down this path, they must carefully examine how they price risk tiers. Kohl cautioned that too many institutions simply price risk tiers based on competition. "Those other local financials likely know little more than you do, unless they are a really big bank, and in that case their price structure is totally different."

Kohl insisted that credit unions, before setting tier pricing, figure out all the components that impact each tier and take a hard look at expense. "For each risk tier, the credit union must determine how much time they will spend on an application, the percentage of apps that could end up being booked, the cost to complete and fund, and the marketing expense per loan booked."

The next step is to estimate how long the loan will be on the books. "If the cost is $500 to originate a loan and you keep it on the books five years, it cost $100 a year," Kohl stated. "If you keep the loan one year, that cost you $500 a year. Then you have to look at collection-related and non-collection related servicing expenses, and of course, factor in loan losses."

Finally, the CU must measure results per loan tier. "That will help you if the examiner hits you over the head about loan losses," Kohl offered. "But if you show him that you are making the least amount of money on A-plus paper and the most on C and D-which can be the case if you price risk tiers correctly-then why not go after C and D credit?"

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