Understanding Risk Can Help Loan Growth
Although credit unions across the country had begun to see increased loan growth through the end of 2012, that loan growth still fell behind competing banks and finance companies. When viewing credit union loan growth in isolation from other lenders, and in combination with share and member growth, it would be easy to surmise that credit unions had found a competitive edge in consumer lending. However, credit unions have lost 25% market share in consumer lending since 2007. The fact is that the growth being experienced by credit unions is also being experienced by their competitors and we are in a rising tide, if you will, where all lenders’ ships are riding high.
How then can credit unions regain lost market share at a time when consumer loan demand is also up? The answer is, quite simply, grow more comfortable with lending risk, and how to successfully manage it, so that credit unions can offer the type of loan products their members need–at a time and place where they need it. For most credit unions that are struggling to increase loan-to-asset ratios, there is a type of loan or group of loans that these credit unions are unwilling to provide. That unwillingness is usually the result of either a past bad experience or a lack of comfort with the risk those type of loans present. Therefore, the way to increase loans in a highly competitive market place would be to find out what happened in the past that made things go so horribly wrong and identify the risks, so that future loans can be originated without falling into the same pitfalls.
Many credit unions across the country will not do RV lending because the potential for loss is very high, as the collateral can depreciate so quickly. Also, because it is a non-essential purchase, many consumers are willing to let go of that collateral when times are bad. But the fact remains that many lenders still do RV loans and offer extended terms to their buyers. Many credit union members have taken advantage of these extended term, low payment loans with other lenders. So, how do these other lenders do it? They understand the risks and model their buying and pricing around those risks.
For example, a lender might be presented with two buyers with the same income and credit score. However, one buyer might have only 5 years of credit experience where the other has 30. When financing “toys,” it’s important that the borrower has a proven payment record over a number of economic cycles. Someone with a limited credit history may not yet have been tested in an economic downturn, especially when that loan has the potential of being in the portfolio for a number of years. Debt-to-income ratios are very important, as well as the type of debt the borrower currently has. Then, of course, “skin in the game” or money down is of great importance.
These are factors we perhaps know from common sense, but how can we know for sure? By monitoring the portfolio using these characteristics, the credit union can validate if assumptions were correct or not. If they were not, and things begin to turn for the worse, you will be able to react more quickly if you’re conducting ongoing portfolio management. One credit union has reported that none of their losses can be traced back to these origination characteristics. In fact every loss they incurred was because of a loss of job, divorce, or death of a member. This is probably true for most credit unions. Very few consumers take out loans intending not to repay them. The question is, “How will they be able to withstand one of these life events if they were to occur?” Lenders can get a better understanding of that by studying their own portfolio against those origination characteristics. Not every loan where the borrower loses his/her job is a loss. So, it’s up to the lending executives to determine what impacts the ones that do. Is it LTV? Or is it time on the job? As mentioned earlier, it may simply be credit experience.
The credit score alone will not reveal this to the lender. It only predicts the changes of default based upon the performance of loans during an observation period. It’s incumbent upon the lender to add the remaining variables that impact severity of loss. The credit unions’ own portfolio performance based on selected risk characteristics can be a better predictor of future loss severities than the credit score alone.
It’s really like the old story about the tennis player who went to the doctor complaining of shoulder pain. He said, “Doc, it hurts when I do this.” The doctor quickly replied, “Stop doing that.” As lending professionals, it’s up to us to make the right diagnosis and stop doing the things that hurt us the most. Like the athlete above, the answer is not to give up playing tennis, but simply stop doing what causes pain. As credit unions, now is not the time to be on the lending sidelines. We simply need to understand what the risks are and avoid them.
