Learning to Make Good Loans to Members with Bad Credit

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1 Learning to Make Good Loans to Members with Bad Credit Lending & Marketing Conference Michigan CU League & Affiliates Grand Rapids, MI February 14, 2012 By Brett Christensen, Owner CU Lending Advice, LLC

MI February 14, 2012 By Brett Christensen, Owner CU Lending

2 Four Undeniable Facts 1. There are very thin margins on A-paper loans. 2. You can make serious money on D and E-paper loans. 3. Members with bad credit need a car to get to work. 4. Members with bad credit can choose to pay their credit union on time. Exhibit A: University FCU, Austin, TX 2

Members with bad credit need a car to get to work. 4.

3 Reasons to Make More Higher-Risk Loans 1. These are the members with the greatest need. 2. These are the members that have the fewest options. 3. Credit unions were formed to serve these members (i.e. the under-served). 4. If you help D and E-paper members they will be very loyal. Can the same be said of A-paper members? 5. An aging population will force you to buy deeper in to the pie in order to maintain loan growth. 6. Aggressive dealer financing will cause you to lose many of your A+ and A-paper member auto loans. 7. You can actually make money on D and E-paper loans. 3

Can the same be said of A-paper members? 5. An aging population will force you to buy deeper in to the pie in order to maintain loan growth. 6.

4 Lending Attitude Check The best lenders learn that lending is both an attitude and an approach. Step back for a minute and consider your lenders ATTITUDE. 1. When your lenders look at a member s credit report and application, do they begin by looking for positives or do they begin by looking at the negatives? 2. Do your lenders know their job? The job of a lender is to evaluate risk and make good loans. The job is not to be offended at a member s personal financial decisions. 4

When your lenders look at a member s credit report and application, do they begin by looking for positives or do they

5 Building Performing High-Risk Loans in the Interview Well-trained employees must be able to obtain the following commitments: Appropriate Collateral An Appropriate Loan Amount A Payment that is Comfortable for Them Cash in our account Down Loan Payment Setup via Automatic Payroll Deduction Credit Life & Disability Insurance Mechanical Breakdown & GAP Insurance Firm Close 5

that is Comfortable for Them Cash in our account Down Loan Payment Setup via Automatic

6 Three Essential Underwriting Approaches for Higher-Risk Lending 1. The Counter-Offer 2. Give a Member Options 3. Use Underwriting Guidelines to Walk Away from Bad Loans; Never the Good Loans And one final point what happens to the money if you take the easy way out and turn down most or all of the members with troubles? 6

Use Underwriting Guidelines to Walk Away from Bad Loans; Never the Good Loans

7 A High-Risk Underwriting Tip From Our Friends at the Fair Isaac Corporation When assigning points gained or lost for payment history information, the FICO score looks at four separate components: 1. Frequency 2. Severity 3. Amount Owed 4. How Recent is the Event Here is how Fair Isaac assigns the severity of a credit problem according to the time it has been on a credit bureau: Timeframe Percent Negative Impact Most recent 12 months 93% Prior 12 to 24 months 60% Prior 24 to 36 months 44% Prior 36 to 48 months 33% Older than 4 years 22% Source: Credit Scores & Credit Reports, Evan Hendricks, Privacy Times, Inc., What do you learn from this FICO score weighting system that you must incorporate when underwriting loans? 7

How Recent is the Event Here is how Fair Isaac assigns the severity of a credit problem according to the time it has been on a credit bureau: Timeframe Percent Negative Impact Most

8 The Most Common Underwriting Mistakes With High-Risk Members 1. Not recognizing bankruptcy risk. 2. Too conservative with the loan-to-value (LTV) decision. 3. Too dependent on your debt ratio calculation. 4. Too conservative with auto loan terms. 5. Too much car = too much payment. 6. Too aggressive with unsecured loans. 7. Too aggressive with youngsters and new members. 8. Denying good loans. 8

Too dependent on your debt ratio calculation. 4. Too conservative with auto loan terms. 5.

9 Lending Money on Old Cars If you truly believe that 8, 10 and 12 year-old car loans with 100,000 plus miles on them are secured, you need to go talk with your collector. I can see why you might take in a title on an old car as opposed to doing a straight-up signature loan, but don t kid yourselves underwrite this request like it is unsecured and price this loan like it is unsecured (because it is unsecured)! As a general statement, I don t think you need to be making auto loans that are more than eight model years back. And if you do make these loans, add a sentence to your policy that states: Any consumer secured loan financed that is more than eight model years old will be priced at our unsecured loan rates. 9

price this loan like it is unsecured (because it is unsecured)! As a general statement, I don t think you need to be making auto loans that are more than eight model years back.

10 Where is the Cash Down? How much are you putting down? This is a mandatory question for every higher-risk consumer secured loan. There is more cash out there to put down on these loans than you think. The member will not come in and offer you their cash down payment. I don t recommend that you let the dealers handle the cash down transaction for higher-risk members. No, I don t care where the cash comes from. Cash down is not a guarantee, but Cash spells Commitment! 10

There is more cash out there to put down on these loans than you think.

11 Your Baby (Total Debt Ratio) Has Issues Three flaws to Total Debt Ratio (TDR): A study was done by the Filene Research Institute a few years ago that found that 65% of all bankrupts had debt ratios less than 40%. The Bottom Line? Members need to be able to afford the new loan payment, but a total debt ratio calculation is not a full-proof method of determining this capability. 11

bankrupts had debt ratios less than 40%. The Bottom Line?

12 Determining the Correct Loan-to-Value You wish making the correct LTV decision was as easy as management drawing some lines in the sand. There are A+ and A-paper members that should be financed at 70% or 80% LTV and there are D and E- paper members that can be financed at 110% LTV. Do you agree that when it comes to underwriting loans, that every member is unique? Your job as an underwriter is risk evaluation. Then how about this for a LTV policy statement? 12

There are A+ and A-paper members that should be financed at 70% or 80% LTV and there are D and E- paper members

13 Secured Loan Amount Guideline When approving a member for a consumer secured loan (autos, RVs, boats, campers, motorcycles), a good guideline for their total consumer secured debt load (less their first and second mortgages) is 50% to 75% of their annual gross income. If the member is A+, A or B-paper, you can look to approve closer to the 75% figure. If the member is C, D or E-paper, you should be closer to the 50% of annual gross income figure. An exception to this guideline can be if a member has put a large amount of cash down on the purchase or has a large positive equity position in the collateral that is being financed. A large amount of cash down or a significant equity position can compensate for a multitude of loanqualifying sins. Unsecured Loan Amount Guideline (For the Total Amount of Unsecured Debt at your Credit Union) A+ & A-Paper Members: Up to 3 times Monthly Gross Income B & C-Paper Members: Up to 2 times their Monthly Gross Income D & E-Paper Members: Up to 1 times their Monthly Gross Income **Just because they qualify for this much unsecured debt with you, doesn t mean they should always be approved for this much! 13

If the member is C, D or E-paper, you should be closer to the 50% of annual gross income figure.

14 An Over Reliance on Co-Signers There are two scenarios that I would not recommend a cosigner: 1. When your member is 25 or older. 2. When the co-signer is a miscellaneous relationship to the borrower. There is only one scenario that I would recommend a cosigner: 1. Mom or Dad co-signing for their 18 to 24 year-old kid. 14

or older. 2. When the co-signer is a miscellaneous relationship to the borrower.

15 Real Risk Factors 1. Youngsters with no or Limited Credit 2. Lousy Jobs (Especially Short Time on a Lousy Job) 3. Renter with no Residence Stability 4. Currently Delinquent Credit Obligations 5. Bankruptcy Filer that did not Learn from the Experience (7-year Itch) 6. Escalating Debt 7. Excessive Unsecured Debt 8. Credit Cards with Balances that are at their Limit (Capacity) 9. A FICO Score on the Way Down 10. Civil Judgments that Affect Monthly Cash Flow 11. Ten Minute C, D, and E-paper Members (Especially Indirect) 12. Debt Consolidation Loans 13. Previous Repossession 15

Bankruptcy Filer that did not Learn from the Experience (7-year Itch) 6. Escalating Debt 7. Excessive Unsecured Debt 8.

16 So How do you Handle Members that Have Real Risk Factors? Start with a secured loan. Lend the member an appropriate amount of money. Put them in to a monthly payment that is comfortable for their budget. Set the payment up on automatic transfer from their payroll or an auto-transfer from an account. Sell insurance products. Get cash down and/or an equity position. Price the loan correctly. Underwrite the loan correctly. Give the member a firm close. Collect the higher-risk loans more aggressively. 16

Set the payment up on automatic transfer from their payroll or an auto-transfer from an account. Sell insurance products.

17 Not-So-Real Risk Factors 1. Old (more than a year), Bad Credit 2. A Recent Bankruptcy Filer and Those Members that have Learned from Filing Bankruptcy 3. A Public Record that does not Affect Monthly Cash Flow 4. Medical Collections 5. FICO Scores on the Way Up 6. The Purpose of a Signature Loan 7. High Total Debt Ratio when there are no Bankruptcy Predictors 8. Reasons for Past Negative Credit 9. A Car Loan that is Upside-Down 17

A Public Record that does not Affect Monthly Cash Flow 4. Medical Collections 5. FICO Scores on the Way Up 6.

18 A High Loan Yield without the Losses Is a Beautiful Thing Greenville Heritage FCU ($52 Million in Greenville, SC) 9/30/11 Peer Yield on Average Loans: 7.79% 6.39% 60-Day Delinquency: 0.19% 1.40% Net Charge-off Ratio: 0.32% 0.67% Avg. ROA for last 5 Qtrs: 2.03% 0.34% Loan Growth last 5 Qtrs: 28.90% 0.14% 18

Loans: 7.79% 6.39% 60-Day Delinquency: 0.19% 1.40% Net Charge-off Ratio: 0.

Loan Processing Credit Reports

Loan Processing Credit Reports Alternative Financing and Telework Loan Programs Annual Meeting Washington, DC December 13, 2004 By Brett Christensen Executive Vice President Lending Solutions Consulting,