Risk Lies Not Among the Lower Income
Too many credit unions have starved themselves on loans that offer security but do not bring much-needed yield.
This was the first part of the gospel of broad-based lending according to Randy Thompson of Thompson Consulting and Training, an Idaho-based consultancy that helps credit unions price and manage loan portfolios.
The second part of Thompson's message was that credit unions have to learn, quickly, how to appropriately price their loans so they can lend to their entire membership base and not just chase the highest credit scores.
Thompson said he is offering a series of webinars on the subject this summer for the National Federation of Community Development Credit Unions.
Thompson's work addresses different facets of loan pricing, risk evaluation and management, but boils down to a foundational observation: Credit unions pricing their loans in simple tiers have reduced their rates dramatically while pursuing a steadily shrinking pool of highest-qualified borrowers.
As proof he pointed to surveys his firm has done with more than 75 credit unions. In 2010, their average A+ paper rate was 4.62%, but by 2013 that had dropped to 2.01%, a plunge of well more than 50% in just three years.
“What we are seeing are phenomena like the $111 million credit union I am working with that doubled the assets in its loan portfolio over the past 18 months, but has seen its monthly income drop by $6,000,” he said, observing these latest borrowers have better credit scores but their loans have not made the credit union enough money.
It's happening across asset sizes and in all parts of the country, Thompson observed, adding it is having the particularly pernicious effect of cutting credit unions off from significant portions of their members.
“Some people have gotten it into their head that lower-income borrowers are necessarily higher risk borrowers and that's just not true,” Thompson said, adding the opposite is often the case.
The C or D paper borrowers are all the more grateful to the credit union for lending to them at a rate almost always much better than they face elsewhere, even if it is not as good as the credit union's A+ rate, Thompson explained. Thus, he said, “That credit union note is often the first paid.”
To counteract the yield and income drop, Thompson, who holds advanced degrees in finance and economics, and TCT help credit unions move away from pricing their loans along a simple tier system that often disregards loan costs toward risk-based pricing.
Risk-based pricing rolls all the costs of a loan into a price that not only covers loan costs, but can add some to the credit union's equity too, Thompson explained. He added that it allows credit unions to get back to serving all of their members again.
Credit unions are not supposed to make bad loans, Thompson observed, but are bad loans only those a credit union charges off or are they also those priced too low to make a credit union enough money?
Lending to its entire membership again is one of the biggest benefits risk-based pricing brought to the $105 million Santa Cruz Community Credit Union in Santa Cruz, Calif., according to CEO Beth Carr.
Carr recounted how the 11,000-member credit union had stopped making loans to many of its low-income members after its regulator expressed concern about the level of risk in the loan portfolio.
“This really hurt us because we had been founded as a community development credit union from the very beginning,” explained Carr, adding that Santa Cruz County, where the credit union is headquartered, has both the wealthy, high-tech capital of the nation in its north and deeply impoverished and heavily Latino areas in its south.
Adopting TCT's approach to using its tools to properly price loans has allowed the credit union to return to serving all its members again, and Carr said she was confident Santa Cruz is on the right track.
“We haven't really had enough time to measure the effect and the call report will not really reflect it yet,” Carr added. She said her credit union had some legacy delinquent loans it was still working through and these further complicated the data.
Meanwhile, Dorrie Shrimpf, CEO of the $18 million Schneider Community Credit Union in Green Bay, Wis., said her 3,700-member credit union has been using TCT's approach for some time to good effect.
Not only does her small institution offer the same loan products a larger credit union might, according to Shrimpf and her credit union's call report, but the credit union ended 2013 with a ratio of delinquent loans to total loans slightly lower than its peer group (1.17% versus 1.26%) and a charge-off ratio sharply lower (0.03% versus 0.45%).
“We are a community-chartered credit union, but the bulk of our members are still the drivers and employees of the Schneider National trucking firm,” Shrimpf said. “Risk-based pricing has helped us keep our loan portfolio sound, even if we are smaller in terms of assets.”