Looking Past Low-Income Credit Scores to Grow Profits
When it comes to underwriting consumer loans, some community development credit unions have found success by looking at other factors besides credit scores.
The three leading national credit bureaus – Equifax, TransUnion and Experian – are meant to provide credit unions and other financial institutions with a guide for their underwriting. A given credit score can help speed up the process and give the credit union a reasonable idea about the likelihood a given borrower will repay the loan.
But credit scores are typically only a quick a summary of a person’s credit history.
Two leading community development credit unions, the 21,000-member, $91 million Shreveport Federal Credit Union in Shreveport, La., and the 27,000-member, $161 million member Hope Community Credit Union in Jackson, Miss., have found going beyond the credit score to be a successful lending strategy.
Shreveport’s loan application system requires that all members who apply for a consumer loan and who have a credit score of below 600 or a bankruptcy in their history have to answer additional questions about their financial history, according to the credit union. This allows Shreveport to both protect itself from any unforeseen risks and to evaluate members who might look worse on paper than they actually do.
“We have found that a lot of our underserved or lower income members might have a credit score which looks discouraging, but which might reflect only a few explainable items,” said Shreveport FCU President/CEO Helen Godfrey Smith, adding that it’s the same process with the bankruptcy questionnaire.
“Yes, they might have had a bankruptcy, but why did they have one? Was it an unavoidable medical expense? An unavoidable job loss? We believe bankruptcy was created to help deal with such things and that a borrower should not be penalized because of them.”
At the end of 2012, Shreveport had a net worth ratio of 15.45%, well above its peer group which is made up of both CDCUs and non-CDCUs, according to its most current NCUA financials. In addition, at 1.48%, the credit union’s return on average assets is roughly three times that of its peers. Shreveport’s ratio of gross income to average assets was 10.37% in December 2012, more than double that of its peers. The credit union also led among its peer group in the average loan yield category at 10.49%.
Smith said the credit union had recently determined that roughly one-seventh of their $70 million loan portfolio was made up of loans that required additional underwriting and $5 million of the portfolio came from loans that the credit union would not have made if it had relied on credit scores alone.
Shreveport’s lending manager, Latonya Kelly, reported that the credit union has 15 loan officers spread out across eight branches. Working with members who need the extra layer of underwriting could have taken a lot of additional time but Kelly said the loan officers have gotten it down to a science to prevent it from killing efficiency.
Still, the additional time and member attention does mean higher costs and that can be seen in the Shreveport’s ratio of net operating expenses to average assets, which was 5.34% compared to the peer average of 2.91% at the end of 2012.
Smith said some of those added costs come from working with a population that tends to want to conduct more transactions in person than over the phone or on a computer. However, she defended the additional costs more underwriting might bring.
“So many of our members would just be put off from applying for a loan at all if it were only done through an automated system,” Smith said. “Many of them already know they don’t look good on paper and many expect us to say ‘no’ already. Working with a loan officer is the only way many will do it.”
Working with a lower-income population may sometimes mean that the credit union’s ratio of charged-off loans to average loans is higher than its peers. Shreveport’s ratio is 0.93% compared to its peers at 0.58%, according to the credit union’s NCUA records.
Smith acknowledged that, but also said the figures have to be considered in context. In 2012, for instance, Shreveport wrote $38 million in consumer loans with $14 million of those requiring the additional underwriting, Smith said. But of that $14 million, which carried a net average interest rate of 12.56%, only $105,000 was charged off. As a result, making those loans was just good business sense, she said.
Hope Community Credit Union takes the Shreveport policy a bit further and does not consider credit scores in deciding whether or not to make a loan at all, however, the cooperative does consider the score when pricing its loans, according to Sandra Patterson, vice president for consumer lending.
Like Shreveport, Hope’s net worth ratio at 11.01% came in higher than its peers, according to the CDCU’s NCUA financials as of December 2012. Its return on average assets lagged at 0.16% compared to its peer group at 0.62%.
Hope had a ratio of net chargeoffs to average loans that is higher than its peers at 0.88% compared to 0.64%. Its yield on average loans was also higher than its peers at 6.31% versus 5.70%.
Patterson said the credit union will let the credit score guide its loan underwriting when they are high, but follows an approach similar to Shreveport’s when it comes to lower scores on loan applications.
Hope’s approach is not as formalized as Shreveport’s is but similar questions are asked to discover the member’s reality behind the credit score, which allows the credit union to also uncover other problems in a member’s financial life, she added. As an example, Patterson described a recent incident when a woman on the edge of retirement had come in for a loan to help replace her car, which had recently become too costly to repair.
Looking closely at her financial situation since she had a credit score on the lower end, Patterson said Hope had identified three active predatory loans the woman had taken out. Hope helped her to pay off the loans and obtain a used car loan to replace her automobile while cutting her overall debt payments by $158 per month. In the end, Hope firmly believes that simply lending to lower income consumers does not have to be unprofitable, Patterson offered.