Convenience, Cost and Profitability: CUs Reconsider Small Loans
Despite the apparent financial pain to cover the underwriting costs of small loans under $600, some credit unions still feel there is a segment of their membership that rely on this type of financing.
However, the market for smaller loans may be shrinking if research from a new CUNA Lending Council white paper is any indication.
According to Fighting for Our Turf: Threats to Credit Union Loan Markets, credit unions used to make more unsecured loans for small ticket purchases like furniture, jewelry, and electronic equipment. A large portion of that market has migrated to credit cards, which have become so pervasive that unused credit lines are typically disregarded in underwriting loans.
“The small loan market has become overcrowded and highly competitive. This has contributed to a limping credit union loan portfolio,” Jim Jerving, the white paper’s author, told Credit Union Times.
Jerving said the research found that most members are unwilling to pay a higher rate on payday loan alternatives offered by credit union when they can get a better rate on a credit card, which might be another reason why small loans are not as prevalent.
“Credit unions are also constrained by membership requirements. They must limit their loans to their field of membership. It is difficult to get the scale needed to be profitable, since only a small segment of members want these loans,” Jerving said.
The Great Recession of 2008 also led to consumers wanting to pay down debt and save more.
Proof of that the trend can be found in the number of homeowners tapping into their home equity for cash-out-refinancing, Jerving said. The amount of equity taken out by homeowners increased from $26 billion in 2000 to a high of $321 billion in 2006. During the housing and financial crisis, that number fell, but even with a recovering housing market and still stagnant economy, only $29 billion was recorded in cash-out-refinancing in 2012, he said.
Increased competition and consumers still cautious to borrow have resulted in a credit union industry loan-to-share ratio of 66.3% for the first quarter of 2013, Jerving said citing CUNA data. At the same time, the net interest margin for the same time period dropped to 277 basis points, which is as low as it has ever been, he said.
Despite apparent roadblocks, small loans can continue to be a viable area for credit unions, Jerving found. Some lenders are moving toward a more holistic underwriting approach that takes a closer look at willingness to pay rather than focusing on the credit score.
“There are a number of credit segments that are being avoided. These are people who suffered credit problems, but were victims of job lay-offs and other misfortunes of the Great Recession,” Jerving said.
In Montana, credit unions continue to offer small loans to meet the needs of their members and communities, said Karen Smith, executive director of Montana Credit Unions for Community Development in Helena, Mont. A few years ago, the office conducted an awareness campaign focused on educating consumers about small loans available at credit unions across the state. While hard numbers aren’t available on usage, Smith said the lending landscape has changed.
“A couple of years ago, the payday lending industry in Montana had the rates capped and we saw the payday lending store fronts close across the state,” she said. “However, the online payday lenders continue to target consumers in our state.”
Still, she said there is an opportunity for credit unions to build awareness as many consumers and members aren’t aware that small dollar loans are an option at their credit union.
Ben Rogers, research director at the Filene Research Institute in Madison, Wis. said he thinks there is still a place for personal loans in the credit union product mix.
“I think they work best as second-chance or starter loans for members who would benefit from personal interaction,” he said. “But I think a lot of credit unions have to make strategic tradeoffs and cut or at least underemphasize the less productive parts of their loan portfolios.”
Personal loans, which are unsecured and have to be underwritten and disbursed, takes employee time, Rogers said. A $5,000 vacation loan, even one written at 10% or 12%, takes a lot more effort for the member and for the credit union than using a credit card that can get the same job done, he explained.
“It takes a lot of $5,000 vacation loans and $2,000 computer loans to make a dent in any credit union’s lending portfolio,” Rogers said. “I think a lot of credit unions say to themselves, ‘why would I chase 100 personal loans if I could just book one extra mortgage for the same amount?’”
Next Page: Accounting for Consumer Demand
That doesn’t even account for consumer demand, Rogers noted. Most members who would qualify for a personal loan already have a credit card anyway and may not want to make the effort to apply for another loan.
Dave Colby, chief economist at CUNA Mutual Group, said the interest rate differential back in 1998 revealed that unsecured loans were priced 51 basis points above credit card rates. Today, the spread has increased to 157 basis points.
The bottom line is credit cards are more convenient and have better terms, he said. During the past 15 years, the credit union share of the credit card market has increased from 3.3% to its current level of 4.9%. And that gain in market share is understated as some credit unions have sold their credit card portfolios, he said.
Additionally, Colby said credit card teasers like 0.00% interest and no payments for a limited term have helped move the product in the same way such teasers have worked for vehicle financing.
As for the use of credit cards as a substitute for small dollar loans, Colby said credit union credit cards balances were up $21.6 billion or 116% over the past 15 years, while unsecured loans were up $4.6 billion or 20% during the same period.
Meanwhile, another area where credit unions may have an opportunity to regain traction with their small loans is through point-of-sale transactions, Jerving said.
“The consumer no longer wants to go to the financial institution for small loans. He wants the loan immediately at the time of purchase,” Jerving said. “This is emblematic of the American culture of immediate gratification in all things carrying a price tag.”
For credit unions, a market opportunity may exist for installment loans for POS purchases at jewelry stores, home appliance and furniture stores, as well as dental offices and elective surgery centers, to name only a few options, Jerving said. The online capability exists to make POS happen effectively and relatively easy for the consumer, he suggested.
If a small loan comeback is possible, credit unions may see yet another way to help members.
“I do see an opportunity for members stuck with high-interest rate revolving debt,” Colby said. “Start a promotion to refinance that debt away to credit union credit cards. Members took the easy loan—financed the purchase on the spot—now improve your finances by getting the best loan at your credit union (as) rates have never been lower.”