Risk-Based Lending Possible Even At Small Credit Unions - Here's How

SAN FRANCISCO—Many credit unions are on a "collision course with disaster" because they are not pricing loans correctly.

That was the message from Randy Thompson, CEO of Thompson Consulting & Training, Eagle, Idaho, who spoke at a breakout session during the California and Nevada CU Leagues' Annual Meeting & Convention here.

He said what many credit unions have been doing simply is creating rate tiers, which he asserted is not working. The interest rate being charged must account for money expended and extended, he advised. Cost of funds and charge-offs are easy to calculate, Thompson noted, but loan operation expenses also need to be accounted for.

"If we take the time to quantify the numbers, then we can be assured they are not tiered rates, but actual risk-based rates," he said.

If 90% of loans CUs book are made only to "A-plus" paper, the margin tends to be very small, Thompson continued. He said they must take risk, but price for it appropriately. "Every credit union will be different," he said. "Costs, rates and margins must be updated quarterly."

Diana Michaels, CEO of $38 million Western Healthcare FCU, Concord, Calif., led the breakout session with Thompson. She said her credit union is a success story that shows a transition from tiered pricing to risk-based is possible.

"Our loan yield had dropped more than 200 basis points," she said. "To improve yield we had to increase certain aspects of risk, without throwing open our doors to all high-risk loans. We needed tools and techniques. We considered pricing for risk grade, for loan-to-value and for term. We do 100% financing for E paper, but they pay for it."

The key to the latter, she said, is to present it as a positive - tell the members who qualify for better rates they are getting it because they are putting 10% down.

To implement risk-based lending, Western Healthcare FCU's loan officers needed direction, Michaels noted. Management had to develop comprehensive and consistent policies, effective risk mitigation techniques and tools, and it had to empirically calculate risk-based pricing.

"For policies, start by clarifying acceptable loans," she advised. "Specify the percent for each grade, the terms for each grade, and the maximum loan amounts and maximum rate spreads for each grade."

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