BOULDER, Colo. – Most discussion about risk-based lending focuses on what it means to members with poor credit. But more than 10 years ago, planners at Premier Members Federal Credit Union – then IBM Rocky Mountain Employees FCU – were concentrating on borrowers with A+ and A paper. The question was how the credit union could issue loans to them as quickly as possible and at the most attractive price. CEO Thomas Evers contacted Coastal Federal Credit Union, a fellow member of the League of IBM Credit Unions. CFCU had researched topics such as FICO scores and risk-based lending, and PMFCU picked up on that model. Evers also talked with TRW, now Experian, about their scoring in order to set up tiers. "Our loan-to-share ratio was a lot lower at the time," notes PMFCU VP/Lending Gregg Hill. "Without doing risk-based pricing we had to price a little bit higher than A+ rates for A+ members to offset the risk for those in lower tiers. You kind of lose the A+ borrowers." That was a particularly heavy hit to PMFCU, blessed with a lot of members with good incomes and high credit scores. Today the credit union offers a risk-based approach on all consumer loans – including home equity, auto loans, signature and VISA – except mortgages. The credit union does have mortgage programs to help C or D borrowers improve their credit so they can move on to better rates. With five lending tiers, the bulk of PMFCU loans and members fall into the A+ tier with 720 and above scores. Speaking of tiers, about four or five years ago PMFCU readjusted the original tiers. Two years later they changed back because the original tiers proved pretty accurate. In 1995 the Boulder County Business Report indicated only one other local credit union had introduced risk-based lending. Now, Hill says, almost all the larger credit unions are involved. Looking ahead, most people expect interest rates to rise. If so, and rates are hiked say 25 basis points, the credit union will most likely simply tack those 25 points onto existing rates. "We do a lot of variable rate lending on the consumer side," Hill says. "As rates move up, that will actually help us. We base all our consumer loans on the prime rate with a margin. On a home equity loan an A+ borrower would get prime plus a half. An A borrower would get prime plus one. Somebody with B credit might get prime plus three. "As the prime goes up, we don't adjust those margins. It's just a matter of the fact that as prime moves up that dictates our interest rate. We've done it long enough our members understand that. When they read in the newspaper the Fed raised rates a quarter point, they realize most of our rates are going to go up accordingly." If that sounds like a program with an Easy Street address, Hill points out there are challenges. "One of the biggest challenges is tracking it," he says. "One of the things we're struggling with now is how to continuously track it and also trace our delinquency ratios and charge-off ratios by tier. NCUA is asking us for more of that data." While still trying to fine-tune that tracking, and acknowledging members with lower credit scores do pose more risk, Hill thinks the higher rates offset that hazard. Besides, he adds, charge-offs and delinquencies can occur in any tier. "We have a lot more members in the 720-plus category. But the reasons we end up charging loans off aren't because of something that happened in the past that would be reflected in a credit report. It's because of something we couldn't predict – they lost their job, they were divorced, they had a medical issue. "We can put everything we want into some kind of underwriting model but we can't predict things like that. The only difference is sometimes people with 700 or better risk scores have a little bit more of a safety net to fall back on," Hill suggests. How do members react to tiers? "We don't have a lot of problems with members who don't like it. It's rare to have a member who is upset about their rate. Everybody is looking to lend to A+ borrowers and give them the best rates," Hill notes. "We probably make the most difference for B, C and D members with lower FICO scores. We're still willing to lend to them. Even though the rate is higher, it's much lower than they are going to pay anywhere else. A D borrower with lower than a 600 FICO score can get a car loan here at 14% whereas at a dealer they're going to pay anywhere from 21 to 30%." Most members, he continues, have a pretty good idea that if they had credit problems in the past they will pay a higher rate. At the credit union they may not pay as high as they expected. "I think it makes them more willing to keep paying," Hill says. "I think the thing we'll probably do more of is true risk-based lending, not necessarily on the pricing side but the underwriting side. We'll start doing different things to speed the process for those A+ borrowers where there's virtually no risk." The goal is to make the system as easy as possible. If someone with a 700-plus FICO requests a home equity loan, is there really much risk? If not, perhaps the process can be streamlined even more. "With the regular pricing model, where everybody gets the same rate, you sometimes exclude people on the far ends of the spectrum," Hill says. "Members with really good credit are probably going to go someplace else where they can get a lower rate. At the same time you're probably going to deny loans to members with poor credit because the risk is too great for the rate you're going to get. "Ultimately you want to serve all your members. Risk-based lending and pricing helps you do that a little bit better. You can pretty much statistically show why you're doing what you're doing." -

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