With advances in technology and shifts in consumer behavior, a number of opportunities exist for offering small loans, according to "Fighting for our Turf: Threats to Credit Union Small Loan Markets," a white paper recently produced by CUNA's Lending Council.
"A rose is a rose is a rose" wrote Gertrude Stein a century ago, but when is a loan not a loan? An account in the April 28 edition of New York Times begs the question and illustrates both the confusion and predatory approach that new lenders sometimes take. A retired military veteran took a "pension advance" from Pensions, Annuities & Settlements of $10,000 for monthly payments of $353 over 60 months for a total cost of $21,180-an interest rate of 36.4% APR.
The pension advance firms say their products are not loans but advances, terminology which serves to evade state usury laws. The "advances" target military veterans with pensions, an age group that is increasingly debt ridden. For households led by those 65 years and older median debt has risen more than 50% from $12,000 in 2000 to $26,000 in 2011, according to the Fed.
Credit unions used to do more unsecured loans that competed with suppliers like the pension advance loans. These loans were typically for small-ticket purchases such as furniture, jewelry and electronic equipment. The credit card has taken the place of financing these purchases during the past 15 years; it has become a substitute for the installment loan, albeit at a higher price. Closely linked to this growth in credit card usage is the aggressive strategy private label credit cards are pursuing.
Long & Winding Road to Yes
Innovations in small loan products face obstacles within CUs-some behavioral others regulatory or economic.
When credit unions were introduced more than a century ago, they were the first peer-to-peer lenders in the United States. Funds were collected from members in the form of savings and those resources were used for loans. It was, and still is, an effective business model. In more recent times, peer-to-peer lending was tried with credit unions, but results were mixed. Zopa began operations in the United States in 2005 and Prosper began in 2006. Zopa is no longer in business in the United States but is still operating in the United Kingdom, but Prosper continues to serve as a peer-to-peer lender in the U.S.
FORUM Credit Union was one of the first credit unions to attempt peer-to-peer lending with Zopa. Members would deposit funds in a CD that would be used for a loan, for instance, with a family member. The organization made only 12 of these loans, according to Brian Crum, VP-lending. "This worked in Europe, but it didn't take off in the United States," he says. "Too many regulations were involved and people didn't understand it."
One of the barriers to offering small loans is that CUs tend to look at the world through A+ paper lenses, according to Tom Boos, CEO at Billings FCU, which has a high-risk loan portfolio. Only 30% to 40% of their loan portfolio comes from "A" and "A+" paper. About 50% to 60% are derived from "C" and "D" borrowers, he says. We try to meet the needs of borrowers who have poor credit," he says. "We try to find a way to say yes."
The road to yes can be paved with delinquency, so the organization will let "A," "A+" and "B" folks go for 16 days with delinquent loans. But "C" and "D" members are contacted within one day of being delinquent. BFCU also uses a "hard" close with "C" and "D" members.
"We talk with them about the credit union and the loan," says Boos. "If you can't make the payment, you need to contact us and we will work with you. We tell them that they have an opportunity to rebuild their credit."
At the end of March 2013, the credit union had a delinquency ratio of 43 basis points and charge-offs of 66 BPs. "We try to keep delinquency at 100 basis points or less and charge-offs at 66 basis points," says Boos.
Key Is To Stratify
Taking on more risk has been a savior for many credit unions, but has caused the demise of others. "If you are doing loans for the credit challenged, it's important to have measuring and monitoring devices," says Boos. "The key is the ability to stratify data from your core processor as well as understanding where you're succeeding and what areas need improvement. Having the proper data allows us to focus."
"Credit unions often focus on delinquency," he says. "A better measure is net yield. Knowing the delinquency ratio alone doesn't get the job done. To effectively manage the process you need to have more detail. If all of our delinquency is in 'D' paper, then we don't worry about trying to tweak our underwriting for the other paper grades."
The Billings approach requires a culture that is receptive to prudent risk taking. The staff has to buy into the concept and the CEO has to sell it to the board. The organization does a fair amount of unsecured credit. "If someone with bad credit comes in and wants $35,000 for a new truck, he won't get that," says Boos. "But we will give him $10,000 if he can find a way to come up with $2,000 for the down payment."
"If they have an account with us-savings, direct deposit, checking-we can work with them," he says. "Our goal is to make all of our members "A+" borrowers."
Multiple benefits accrue to the organization for doing more business with "B" and "C" credit members. Loan volume is boosted and the relationship with the member is deepened. If the loan experience is positive, they will be back for other products. And the mission of the financial cooperative is advanced.
These lenders are following the best of cooperative principles by trying to find a way to say "yes." The road to "yes," of course, can be filled with potholes. This is a valid concern, but are we as an industry and a movement, overly concerned with serving "A" members while bypassing others with credit challenges?
Jim Jerving is a freelance writer based in Madison, Wis. He can be reached at firstname.lastname@example.org.