Subprime (With Controls) Pitched As Yield Booster
Credit unions looking for additional loan dollars were urged to look a little more deeply into their lending criteria and whether there isn't opportunity to consider more subprime loans.
Steve Martin, VP-Lenders Protection with CUNA Mutual Group, told the CUNA Lending Council that not only are there revenue-related reasons for considering lower credit scoring-members for loans, there is the core issue of serving all the membership.
"In addition to increasing loan yields, non-prime provides a viable lending alternative for underserved members," he said.
Martin said he defines the "non-prime" member as the borrower with a credit score below 700, a group he said includes some 40% of all borrowers and a market that originated about $300 billion in vehicle loans through all financial institutions nationwide last year.
"The nonprime vehicle market is approximately $300 billion during 2004, and 30%-plus of that business has gone to the auto captives," said Martin. "Beyond that, the market is very fragmented, and as no one owns it, credit unions have a terrific opportunity."
Rates in subprime lending typically run in the 12% to 23% range. "But people in this market don't buy interest rates, they buy payments," said Martin. "Because they are buying payment, you can cover your risk and still make 100 to 200 basis points. The opportunity is there to make a whole lot more loans and make a lot higher ROA than you're making today, and still deliver an interest rate to that member that they are not getting today."
CUNA Mutual's analysis has shown that less than half of the nation's 9,100 credit unions do non-prime lending, which is typically associated with vehicle lending, but can apply to any type of lending. Martin pointed folks to www.myfico.com, where data on credit card distributions across the population can be found.
Martin noted there are risks such as increased loan defaults, working with dealers instead of directly with members, application fraud, and repossessions.
However, these can be addressed through careful planning, commitment and implementation. Employee education is vital, and frontline staff should be aware handling non-prime lending is different from prime.
How big can nonprime lending be for credit unions? CUNA Mutual estimates that credit unions turned down during 2004 as much as $50 billion in loans overall, 50% of which would be nonprime. In addition, he said there is approximately another $15 billion that was approved but not booked.
One hidden opportunity in the non-prime market, according to Martin, lies with members who are approved for a loan, but are never booked as the member takes the loan elsewhere. It's very likely those members actually got a worse deal elsewhere, he suggested.
"I'm convinced you can provide them with enough of a savings that they will bring that loan back to you," said Martin. "If you get the word out there, that flow will increase."
Profitability is strong because the loan can be priced up and still beat the member's current rate, and these same loans stay on the books for a longer period, providing higher yields.
The key remains monitoring the risks. Few, he said, have employed the "magic bullet" generating a monthly assumed fault prepayment curve with a comparison to actuals.
"If you see something early on it can give you reason to keep an eye on something," said Martin. "There is one credit union we're working with that is running about twice the default rate (projected), and they are adjusting their pricing."