Pricing models in Section 3 vary considerably. The models can help you price your product based on risk and volume assumptions.

Transcription

1 4. Product Pricing Pricing your new loan product can be challenging, given that it is short-term and riskier than most traditional loan products. This section provides tools and guidance to help with this important product development issue. An interactive Excel spreadsheet is available in the REAL Solutions Impact Center as a separate file to help you make pricing decisions. It is located at: The spreadsheet contains two tabs one for closed-end loans and one for open-end models. Instructions for using the spreadsheet follow in Exhibit 1. Pricing models in Section 3 vary considerably. The models can help you price your product based on risk and volume assumptions. A few observations are in order regarding pricing: 1. At least 13 states have passed laws limiting the cost of short-term payday loans (PDLs), with 36% often set as the cap. Many of these actions have been prompted by policymakers and consumer groups concerns about borrowers paying usurious rates for loans that ensnare them into a debt trap they can t escape. Credit unions should be aware of, and take into account, the applicable laws and regulations. 2. Payday lenders have moved out of those states with severe pricing restrictions leaving many consumers with limited financial options or perhaps even more costly options. Credit unions have an opportunity perhaps even an obligation to come forward and provide a better loan alternative. 3. Credit unions should be aware of the pricing restrictions that affect military personnel and their families. See Section 5 Regulations in this guide. 4. Credit unions that choose to charge an application fee should be able to justify the costs of that fee. An application fee must be charged to all applicants of that loan type whether approved or not in order for the fee to be excluded in the APR. For further discussion regarding Finance Charges under Reg Z, see Section 5 Regulations. 5. Some of the models featured in Section 3 are located in states without restrictive usury or PDL regulations and their rates may exceed the APRs preferred by some consumer groups (generally in excess of 36%). The purpose of this implementation guide is to offer credit unions a variety of existing and successful models. It avoids judgment as to what constitutes an optimal rate. In the end, that is the decision of the credit union based on its individual philosophical values. 6. Featured credit unions that offer products with higher APRs justify those costs based on labor and loss expenses. Generally risks are greater because no minimum membership period is required. These credit unions are also apt to offer incentives to members to take advantage of financial education programs to improve their financial stability, which can increase processing and servicing costs. Payday Lending: A REAL Solutions Implementation Guide 70

2 Exhibit 4: CLOSED-END Formulas CU Name: Example 1 CU Loan Portfolio Loan Amount 500 CU # Members Loan Term in days 90 % of Members Using PDL Product 0.01 # days between payments 30 # Members Using PDL Product =E3*E4 Number of payments =B4/B5 % of Consistent Users 0.75 Number of loan periods/yr 4 # of Consistent Users =E5*E6 Annual Interest Rate 0.18 Average Loan Amount 300 Periodic Interest Rate =(B8/360)*B5 Average # Advances/Yr 3 Periodic Payment =PMT(B9,B6,-B3) Total # Loans/Yr =E7*E9 Cost of Funds 0.02 Total $ Loans Made =E10*E8 Avg Outstanding Balance =E11/B7 Income: Income from Loans =E12*B8 Interest Income =B10*B6-B3 Income from App Fees =E10*C15 Application Fee 20 Other Fee Income =E10*C17 Other Fee Income Total Income =SUM(E13:E15) Late Fee 15 =(B27*B17)/B6 Total Income per Loan Advance =C14+C15+C17 Expenses: Credit Checks =C21*E10 Expenses: Loan Labor Costs =C24*E10 Credit Check 1 Collection Labor Costs =C29*E10 Time to generate/service a loan in hrs 0.5 Loan Loss Expenses =E11*B30 Hourly salary 14.5 Cost of Funds Expenses =E12*B11 Loan Labor Costs =B23*B22 Total Expenses =SUM(E19:E23) Cost of Funds =((B3/B7)*B11/B6) Other Overhead 0 Total Income =E16-E24 Delinquency Ratio/Mo/# Borrowers 0.12 Collection time per deliq loan in hrs 0.5 Collection Expenses per loan =(B23*B28)*B27 Loan Loss Ratio/Total $ Loans Made Loan Losses per loan =B3*B30 Total Loan Expenses per Loan =SUM(C21:C31) Total Income per Loan Advance =C18-C32 Payday Lending: A REAL Solutions Implementation Guide 80

3 Exhibit 3: OPEN-END Worksheet CU Name: Example 2 CU Loan Portfolio Notes: Loan Amount $500 CU # Members 26,700 Loan Term in days 90 % of Members Using PDL Product 1.00% # days between payments 30 # Members Using PDL Product 267 # Members using PDL over 1 yr Number of payments 3 % of Consistent Users 90% % Members consistently using product Number of loan periods/yr 4 # of Consistent Users 240 # Members consistently using product Annual Interest Rate 18% Average Loan Amount $300 Avg rather than max Periodic Interest Rate 1.50% Average # Advances/Yr 3 Periodic Payment $ Total # Loans/Yr 721 # Consistent users X avg advances Cost of Funds 2% Total $ Loans Made $216,270 # Loans X avg loan amount Avg Outstanding Balance $54,068 Total $ loans/# loan periods/yr Income: Income from Loans $9,732 Avg outstanding X APR Interest Income $15.07 Income from Annual Fees $13,350 Total # users X annual fees Annual Fee $50.00 Other Fee Income $433 Total # loans X late fee/loan Other Fee Income Total Income $23,515 Late Fee $15.00 $0.60 Total Income per Loan Advance $65.67 Expenses: Credit Checks $267 Cost of credit check X total # users Expenses: Loan Labor Costs $2,613 Labor costs X total # loans made Credit Check $1.00 Collection Labor Costs $627 Collection costs X total # loans made Time to generate/service a loan in hrs 0.25 Loan Loss Expenses $4,758 Total $ loans made X loss ratio Hourly salary $14.50 Cost of Funds Expenses $1,081 Avg Outstanding Bal X COF ratio Loan Labor Costs $3.63 Total Expenses $9,347 Cost of Funds $0.83 Other Overhead $ - Total Income $14,168 Delinquency Ratio/Mo/# Borrowers 12% Collection time per deliq loan in hrs 0.5 Collection Expenses per loan $0.87 Loan Loss Ratio/Total $ Loans Made 2.20% Loan Losses per loan $11.00 Total Loan Expenses per Loan $17.33 Total Income per Loan Advance $48.35 Payday Lending: A REAL Solutions Implementation Guide 79

4 Exhibit 2: CLOSED-END Worksheet CU Name: Example 1 CU Loan Portfolio Notes: Loan Amount $ 500 CU # Members 26,700 Loan Term in days 90 % of Members Using PDL Product 1.00% # days between payments 30 # Members Using PDL Product 267 # Members using PDL over 1 yr Number of payments 3 % of Consistent Users 75% % Members consistently using product Number of loan periods/yr 4 # of Consistent Users 200 # Members consistently using product Annual Interest Rate 18% Average Loan Amount $300 Avg rather than max Periodic Interest Rate 1.50% Average # Advances/Yr 3 Periodic Payment $ Total # Loans/Yr 601 # Consistent users X avg advances Cost of Funds 2% Total $ Loans Made $180,225 # Loans X avg loan amount Avg Outstanding Balance $45,056 Total $ loans/# loan periods/yr Income: Income from Loans $8,110 Avg outstanding X APR Interest Income $15.07 Income from App Fees $12,015 Total # loans X app fees Application Fee $20.00 Other Fee Income $360 Total # loans X late fee/loan Other Fee Income Total Income $20,486 Late Fee $15.00 $0.60 Total Income per Loan Advance $35.67 Expenses: Credit Checks $601 Cost of credit check X total # loans made Expenses: Loan Labor Costs $4,355 Labor costs X total # loans made Credit Check $1.00 Collection Labor Costs $523 Collection costs X total # loans made Time to generate/service a loan in hrs 0.50 Loan Loss Expenses $3,965 Total $ loans made X loss ratio Hourly salary $14.50 Cost of Funds Expenses $901 Avg Outstanding Bal X COF ratio Loan Labor Costs $7.25 Total Expenses $10,345 Cost of Funds $0.83 Other Overhead - Total Income $10,141 Delinquency Ratio/Mo/# Borrowers 12% Collection time per deliq loan in hrs 0.5 Collection Expenses per loan $0.87 Loan Loss Ratio/Total $ Loans Made 2.20% Loan Losses per loan $11.00 Total Loan Expenses per Loan $20.95 Total Income per Loan Advance $14.72 Payday Lending: A REAL Solutions Implementation Guide 78

5 Open-End Work Sheet Example 2 CU We use the same product features as in the closed-end spreadsheet with one exception: we have replaced the application fee with an annual fee. The following differences are noted between the openend and closed-end spreadsheets: Per Loan Calculations: Under income, an annual fee is assessed in lieu of an application fee. An application fee is charged with each loan whereas the annual fee is charged just once per borrower. However, the fee is charged whether the borrower uses the product just once or continuously throughout the year. Under expenses, the time to generate/service the loan has been reduced to 15 minutes instead of 30 minutes. While the initial set-up could still take 30 minutes, subsequent advances will likely occur at the teller line, reducing labor expenses. Total income per loan advance is considerably higher at $48.35 than under the closed-end scenario because an annual fee is higher than an application fee of $20. Loan Portfolio Calculations: The percent of consistent users has been increased to 90% from 75% for the closed-end scenario. The assumption is that members willing to pay the annual fee of $50 will be more likely to use the product during the year. Income from annual fees is calculated by multiplying the annual fee amount by the number of members using the product rather than the number of loan advances. Loan labor costs are half of the costs under the closed-end structure. Credit check expenses are based on number of users rather than number of advances. Total income under this scenario is more than $4,000 higher than under the closed-end structure. Is an annual fee better than an application fee? The answer is: it depends. The closed-end example assumes 75% of users will pay an average of $60 per year in application fees to use the product three times. However, 25% will only pay one fee of $20. Under the open-end example all users pay the $50 regardless of how many times it is used. A closed-end product with a shorter loan term but with the same percentage of consistent users will probably generate more income. For example, using the closed-end spreadsheet and changing the loan term to 30 days, the number of loan periods/year to 12, and the average number of advances/year to 9, will produce total net income of $18,167. The structure and pricing decisions are based on what your credit union s mission or objective is in offering this product and its pricing philosophy. Good Luck! Payday Lending: A REAL Solutions Implementation Guide 77

6 Loan Labor Costs: The spreadsheet multiplies labor cost per loan by total number of loans, or $4,355 for our example. Collection Labor Costs: The spreadsheet multiplies collection labor per loan by total number of loans, or $523 for our example. Loan Loss Expenses: The spreadsheet multiplies total $ loans made for the year by the loan loss ratio of 2.2% for our example. Estimated losses are $3,965 for our example. This is an average of $6.60 per loan, less than our calculation of $11 on a per loan basis. Remember however, our individual loan example was for $500. Our average loan in the portfolio is $300. The loan loss ratio to average outstanding balance is 8.8%. Cost of Funds Expenses: The spreadsheet multiplies average outstanding balances by the cost of funds (COF) ratio inserted into cell B10. The result in the example is $901. Total Expenses: All expenses are added and sum to $10,345 in our example. Total Income: Total net income for our portfolio example amounts to $10,141. What about the 25% who only use the product once? Well, just change cell F5 to 25% instead of 75% and change cell F8 to 1 instead of 3 and you will see that total income is now $1,177. So even those borrowers who use the product just once will produce positive income. Good Luck! Payday Lending: A REAL Solutions Implementation Guide 76

7 # Members Using PDL Product: Using our example of 1%, 267 members are estimated to use the product during the year. % of Consistent Users: There are a couple of ways to try to estimate usage. One way is to estimate consistent users those who will use the product more than once or twice a year. Experienced credit unions find 50% to 75% are consistent users. Another way is to estimate the average number of advances per year for both consistent and casual users. If you prefer to use the second method, skip this cell and proceed to Average Loan Amount. For our example with a 90-day term, we estimate 75% of users will use the product two-to-four times a year. Many credit unions also limit the number of rollovers or times members can use the product during a 12- month period. Others encourage or require some form of counseling with regular usage. Such limitations should be factored into your percent of users or average number of advances. # of Consistent Users: Using our 75% calculation, 200 members are expected to use this product consistently. Average Loan Amount: This amount can vary depending on your maximum loan amount and term. In our product example with a 90-day term, we use $300 as the average loan amount at any one time. Experienced credit unions report averages between $300 and $350 when the maximum loan is $500. Those with higher maximums report higher averages. Average # Advances/Year: Remember that the example is for consistent users. In our product example with a 90-day term, we use 3 advances as the average per year. If you prefer to include an estimate of advances for both consistent and casual users, you can either insert another calculation for casual users or modify your average number of advances downward to include both. Total # Loans/Yr: The spreadsheet multiplies the number of consistent users by the average advances per year to arrive at a total of 601 for our example. If you modified your average number of advances/year to include both consistent and casual users, you will need to change this formula to point to cell F4 instead of F6. Total $ Loans Made: The spreadsheet multiplies the total number of loans by the average balance to arrive at total $ loans for the year of $180,225. Avg. Outstanding Balance: The spreadsheet calculates average outstanding balance by dividing total $ loans made during the year by number of loan periods in year. In our example, this is $45,056. Income from Loans: The spreadsheet calculates interest income from loans by multiplying the average outstanding balance by the annual interest rate, which for our example is 18%. The result is interest income of $8,110. Income from App Fees: The spreadsheet calculates income from application fees by multiplying total number of loans by the application fee. For our example, the income is $12,015. Other Fee Income: In the example we use only a late fee for other income. The spreadsheet calculates the income by multiplying total number of loans by late fee per loan. The income for our example is $360. Total Income: All income sources are added and sum to $20,486. Expenses: Credit Checks: The spreadsheet multiplies total number of loans by the cost per credit check which is $601 for our example. Payday Lending: A REAL Solutions Implementation Guide 75

8 Here are some credit union examples: A 14-day loan product set up to resemble a payday loan that accepts post-dated checks, charges loans off after 45 days, and has 8% of its loans delinquent. A 60-day loan product that does not require direct deposit, and has 9.5% of its loans delinquent. A 90-day loan product that does not require direct deposit, and has 15% of its loans delinquent. A 30-day loan product that does not require direct deposit, and has 10% of its loans delinquent. A 120-day loan product that does require direct deposit, and has less than 2% of its loans 30 days or more delinquent. Collection Time per Delinquent Loan in Hours: Time will vary depending on how much collection effort you plan to put into these small short-term loans. On average, credit unions make one or two phone calls and send one or two letters. In the example, we ve used 30 minutes of time. Collection Expenses per Loan: The spreadsheet calculates this expense based on the amount of time, salary, and estimated percentage of loans that are delinquent. Loan Loss Ratio/Total $ Loans Made: The more accurate calculation is loan loss ratio/average outstanding balance. However, most credit unions calculate their loss ratio based on total $ loans made. Not only is the ratio much smaller but average outstanding balances can change quite a bit with a new product. As with delinquency, loss ratios vary considerably. The spreadsheet example uses 2.2%. Some other examples: Payday lending industry losses average about 4% of total volume. A 30-day loan product that does not require direct deposit has a loss ratio of 1.1% of total volume and 10% of average outstanding volume. A 30-day loan product that does require direct deposit has a loss ratio of.67% of total loan volume. A 120-day loan product that does require direct deposit has a loss ratio of.31% of total volume and 1.9% of average outstanding volume. A new 60-day loan product that does not require direct deposit has a loss ratio of 9% of total loan volume. Loan Losses per Loan: For our $500 loan example with a loss ratio of 2.2%, the loss per loan is $11. Total Loan Expenses per Loan: Total loan expenses for our example add up to $ Total Income per Loan Advance: The spreadsheet calculates total income. For our example, income is $14.75 per advance. Loan Portfolio Calculations: If you are satisfied with your individual loan calculations, it is time to start on your portfolio estimations and calculations. CU # Members: Insert the number of members your credit union has. The example uses a membership of 26,700. % of Members Using PDL Product: This will vary based on the age of your product and how aggressively you market it. Whereas estimates as to the percentage of credit union members using payday lenders vary between 10% and 20%, most credit unions experience somewhat less than 1% for a new product to 10% for a mature product. In our example, we use a conservative estimate of 1% for a new loan product. Payday Lending: A REAL Solutions Implementation Guide 74

9 late fee. However, the late fee is only assessed on delinquent loans, so the income per loan is based on the estimated percentage of loans that will be delinquent (Delinquency Ratio/Mo/#Borrowers), which in our example is 12%. In our example, the loan term is 90 days, so the fee income is further divided by the number of payments. Obviously, this isn t a perfect calculation for late fee income because it is possible for this loan with three payments to be charged a late fee for each payment. On the other hand, the delinquency ratio includes those loans that are over 30 days past due, even though it is likely the loan will be charged for only one late payment regardless of degree of delinquency. Given your need for perfection, you can further tweak the estimate and calculation to your liking. Total Income per Loan Advance: The spreadsheet calculates the total income per loan advance based on interest income, application fee and other income. For our example, the total income is $ Expenses: Credit Check: If you plan to do a credit check, either through a subprime credit bureau or one of the mainstream credit bureaus, the cost should be factored in under expenses. For our example, we ve used $1. Time to Generate/Service a Loan in Hours: In our example, we use ½ hour. Depending on how efficiently you plan to process your loan, this time can vary significantly. If you plan to model payday lenders, the time should be between 10 to 20 minutes. Loan servicing time should be minimal, but it is included here as part of loan generation time. Hourly Salary: Depending on whether you plan to have your tellers or loan people handle the loan, salary levels will vary. In our example, we use an average rate of $14.50 that could also cover a collector s salary, as well. Loan Labor Costs: The spreadsheet will calculate loan labor costs based on your input. Cost of Funds: The spreadsheet calculates your cost of funds for the loan, using your cost of funds rate. The cost of funds rate, however, is an annual rate. The spreadsheet divides the loan amount by the number of loan periods in the year, which in the example is four periods. This is multiplied by the cost of funds rate. However, in the example, the loan is repaid over three payments, so the loan amount is not outstanding for the whole period. The product therefore is further divided by the number of payments, producing a cost of funds of $.83 for the $500 loan. Other Overhead Costs: While we have left this cell empty, you may want to factor in any depreciation expenses that may be associated with special software for your payday loan product, marketing expenses for the product, additional cash on hand, supervisory expenses, etc. In particular if you are charging an application fee, you should be able to justify that fee to examiners. It is certainly reasonable for a loan product to cover direct expenses associated with the product as well as indirect operating expenses. The cell in the spreadsheet is set for a dollar amount, but a percent of overall operating expenses or cost of office space is also reasonable. If your credit union plans to use a savings component or incentives for financial education, those options will increase your costs per loan and should either be included in other overhead costs or added as separate line items. Other loan product expenses could include tracking cross-sales as part of a migration strategy to move members into other credit union products and services. Delinquency Ratio/Mo/#Borrowers: As noted earlier, the example uses 12%. This is going to vary widely depending on your loan term, collection and charge-off practices, and whether or not your loan product requires direct deposit. Direct deposit mitigates delinquency and loss risk tremendously. Payday Lending: A REAL Solutions Implementation Guide 73

10 Exhibit 1: Spreadsheet Instructions This interactive spreadsheet assumes some knowledge of Excel. Some formulas have been inserted to automatically calculate payments, periodic interest, and income and expenses, based on certain inputs. The spreadsheet can easily be expanded into additional columns to look at various model scenarios and/or by years, with different assumptions as a product matures. Cell references are not fixed or absolute, meaning that as you copy formulas, cell references will be adjusted. If you want absolute cell references (so they always point to a particular cell), use the F4 function key in the formula bar to position the desired cell reference. The first thing we suggest is that you save the original worksheet under one file name, then play with it under different file names so that you always have the original to revert back to, if necessary. Closed-End Worksheet Example 1 CU The three columns on the left provide income/expense information per loan. They enable you to determine if your pricing structure is adequate on a loan by loan basis. The two columns on the right determine income/expenses based on a portfolio of loans. They can help you determine the bottom line impact the product will provide, based on usage assumptions. Per Loan Calculations: Loan Amount: Input a loan amount. The example uses $500, but you can insert any amount. Loan Term in Days: Input the number of days you want for a loan term. The example uses 90 days. # Days between Payments: Input the number of days between payments. This may vary depending on how often a borrower is paid. As the number of days change, you can see the effect it has on interest income. The example uses 30 days. Number of Payments: The spreadsheet calculates the number of payments based on your input. Number of Loan Periods/Yr: Our example uses a 90-day loan term, or 4 loan periods per year. For a typical 14-day payday loan, the number of loan periods would be 26. Annual Interest Rate: Input the interest rate you plan to charge on your loan product. Periodic Interest Rate: The spreadsheet will calculate the periodic interest rate based on your annual rate and number of days between payments. Periodic Payment: The spreadsheet will calculate the payment per period based on loan amount, number of payments, and periodic interest rate. For the example used here, a $500 loan at an 18% rate will result in three payments of $ Cost of Funds: Input the average cost of loan funds. The example uses 2%. Interest Income: The spreadsheet calculates the interest income for this loan over the desired period of time. In the example, the interest income is $ Application Fee: If you plan to charge an application fee, that amount should be inserted here. Other Fee Income Late Fee: Here you can insert other fee income that may be associated with a loan product such as NSF income for payment from a bad check or late fees. The example uses a $15 Payday Lending: A REAL Solutions Implementation Guide 72

11 NCUA Pricing Guidelines At least one NCUA examiner offers this simple break-even pricing strategy for a PDL-alternative product, given that federal credit unions can t exceed 18% APR: Calculate the credit union s average cost of funds and average operating expenses, and then estimate the charge-off ratio for the product to determine if an 18% rate will cover the costs. For example: Average operating expenses 4.0% Average cost of funds 2.3% Estimated charge-offs 10.0% Total expenses 16.3% APR 18.0% Net income (APR - total expenses) 1.7% The charge-off calculation is made by totaling net charge-offs for the product over the past12 months and dividing by the average outstanding balance for the product. This is easy to calculate once you have one year of history. Estimating charge-offs as you go into a new product is more difficult, but using 10% as an estimate is probably safe. This section includes the following Exhibits: Spreadsheet Instructions (Exhibit 1) Closed-End Worksheet hard copy of the interactive spreadsheet (Exhibit 2) Open-End Worksheet hard copy of the interactive spreadsheet (Exhibit 3) Closed-End Formulas used in the interactive spreadsheet (Exhibit 4) Open-End Formulas used in the interactive spreadsheet (Exhibit 5) Payday Lending: A REAL Solutions Implementation Guide 71

12 Exhibit 5: OPEN-END Formulas CU Name: Example 2 CU Loan Portfolio Loan Amount 500 CU # Members Loan Term in days 90 % of Members Using PDL Product 0.01 # days between payments 30 # Members Using PDL Product =E3*E4 Number of payments =B4/B5 % of Consistent Users 0.9 Number of loan periods/yr 4 # of Consistent Users =E5*E6 Annual Interest Rate 0.18 Average Loan Amount 300 Periodic Interest Rate =(B8/360)*B5 Average # Advances/Yr 3 Periodic Payment =PMT(B9,B6,-B3) Total # Loans/Yr =E7*E9 Cost of Funds 0.02 Total $ Loans Made =E10*E8 Avg Outstanding Balance =E11/B7 Income: Income from Loans =E12*B8 Interest Income =B10*B6-B3 Income from Annual Fees =E5*C15 Annual Fee 50 Other Fee Income =E10*C17 Other Fee Income Total Income =SUM(E13:E15) Late Fee 15 =(B27*B17)/B6 Total Income per Loan Advance =C14+C15+C17 Expenses: Credit Checks =C21*E5 Expenses: Loan Labor Costs =C24*E10 Credit Check 1 Collection Labor Costs =C29*E10 Time to generate/service a loan in hrs 0.25 Loan Loss Expenses =E11*B30 Hourly salary 14.5 Cost of Funds Expenses =E12*B11 Loan Labor Costs =B23*B22 Total Expenses =SUM(E19:E23) Cost of Funds =((B3/B7)*B11/B6) Other Overhead 0 Total Income =E16-E24 Delinquency Ratio/Mo/# Borrowers 0.12 Collection time per deliq loan in hrs 0.5 Collection Expenses per loan =(B23*B28)*B27 Loan Loss Ratio/Total $ Loans Made Loan Losses per loan =B3*B30 Total Loan Expenses per Loan =SUM(C21:C31) Total Income per Loan Advance =C18-C32 Payday Lending: A REAL Solutions Implementation Guide 81