Mounting evidence suggests subprime lending offers a significant growth opportunity for credit unions, but not without significant risk. Credit Union Journal talked with four credit unions that are successfully offering these loans, providing a deeper look at this strategic product, the potential pitfalls and how to avoid them.
CALCOE FCU
CALCOE Federal Credit Union, a $28-million institution based in Yakima, Wash., launched its "Credit Builder" program in May 2013 and is offered in conjunction with its indirect auto lending program, according to Ryanne Nesary, marketing director at CALCOE.
Since launching the program, CALCOE has sold 507 loans for approximately $5.6 million in volume. About 140 of those loans have been delinquent at some point.
CALCOE mitigates risk through rigorous loan pricing methods. "Collections and charge-offs can be very costly," Nesary said. "We price loans according to their risk; the subprime loans are priced from 12% to 18% APR."
Another key to success: using "very active" collections practices. "For the subprime segment, our collections department is active from [the] day after the borrower misses a payment with phone calls and letters," Nesary noted. "In addition, we use proactive practices – letting members know from the beginning that if financial issues arise to call us so we can work with them on their payments, etc. Also, [we give] borrowers convenient payment options, such as from a debit or credit card."
Underwriting management is also vital. "Management and the collections committee regularly look for commonalities of charged off loans from which common factors are identified," she stated. "With that information, underwriting changes may be made or just communicated to the lending department."
If a credit union is looking to grow auto loans without having to compete in the prime borrower market, subprime lending is "definitely an option," Nesary said, but only if the credit union is aware and able to handle the risks and challenges that come along with it.
"The subprime market provides a niche market, a larger margin, and the knowledge the credit union's loans are actually helping most of the borrowers, which can be greatly rewarding," she said. "However, it can present endless challenges at times. Challenges include everything from the inexperience or lack of knowledge of lending by the borrower to allowance for loan loss. The credit union must remember in many ways the subprime market is very unique."
Firefly FCU
Firefly FCU, the $1 billion institution formerly known as US FCU based in Burnsville, Minn., got into subprime auto lending in conjunction with the Filene Research Institute's pilot aimed at increasing lending volume in local markets.
"We have originated over 900 loans for about $9.1 million in originations," said Firefly SVP-Member Service Rick Blood, adding that about 5% have gone delinquent.
Firefly mitigates risks by attempting to "identify members that have demonstrated repayment on comparable credit products," he explained. "For example, they may have had some credit issues, but they have had a car loan in the past and they have maintained their payments on that car loan."
In addition, Firefly only wants to finance the member's primary vehicle. "We limit the loans to a maximum of $20,000," he noted. "We also collect additional personal references at application to provide our Solution Advisors [collections officers] additional information for locating the member should payment issues arise. We identify these loans within about five days of a delinquent payment and reach out with a phone call to the member to make payment arrangements."
As to whether credit unions should sell subprime auto loans, Blood thinks that would depend upon the institution's particular balance sheet and appetite for risk. "I think there is definitely an opportunity to serve members in this space, but it needs to fit in with the credit union's long term strategic goals," he said. "[They need to] have a well thought out plan of action and [subprime auto loans should] be something the credit union is willing to invest the appropriate amount of resources in to manage the risk."
Summit CU
Penny Armagost, VP lending, analytics and credit risk at Summit Credit Union, a $2.4-billion institution based in Madison, Wis., said her credit union doesn't have a "formal" subprime auto loan program, but they do originate loans in a C and D tier, which may be perceived as subprime lending.
"We have just over 10,000 C and D loans in our portfolio with a total balance of $107 million," she said. "We originate through an indirect and direct channel. The volumes are very similar in each of the channels."
Armagost noted Summit has about 150 loans that are more than 60 days delinquent in those categories, amounting to about $1.4 million in loan balances.
"We mitigate our risks with a thought-out strategy for growth, and with our staff following procedures and policies," she explained. "Loan analytic reports around the loan program are done on a routine basis. We also have effective collection and servicing teams that communicate frequently with our underwriting staff to share notes trends."
Armagost recommends that if other credit unions seek to enter the subprime space, they should employ a "well-thought-out" origination plan and to make sure staffing is in place in all areas of the process: origination, underwriting, servicing, and collections.
"Usually servicing or collections is not thought out until 12 to 18 months into the process, and the portfolio could deteriorate quickly without having those areas built up early on," she added. "All staff members following policies and procedures and management routinely reporting on the portfolio will be key to the process."
CASE CU
CASE CU, Lansing, Mich., was inspired to establish a formal subprime offering after the $259 million credit union sent staff to a National Federation of Community Development Credit Unions conference in late 2014.
"We concluded that we had been doing subprime loans for some time, primarily as an exception loan," explained Karen Casler, compliance manager and product development manager at CASE. "On our return we began to flesh out a formal subprime auto loan program for the credit union. We anticipate a formal program roll out in July with beta testing in June."
Currently CASE CU has 176 such loans on the books at a total portfolio of $1,425,000. Delinquency rate plus charge- off for this portfolio is at 10.13%.
In order to mitigate risk of these loans, she noted, they have developed underwriting guidelines specifically for this type of loan, including a careful review of loan-to- value ratio, term limits, evaluation of age of car and mileage, and debt-to-income ratio.
Moreover, CASE specifically uses only highly seasoned loan officers to underwrite this type of loan, and uses very proactive collection efforts.
"We recommend automatic payments and encourage direct deposit if possible," she added. "We will utilize more aggressive collection efforts starting at one day past due to mitigate the risk of loan losses. This group will have a specifically assigned collector to assure frequent collection contact."
As a CDCU, CASE's mission is to serve low- to moderate-income people and communities, so this program vital to fulfilling that vision. "CDCUs specialize in fairly priced loans including members with imperfect, limited or no credit history," Casler noted. "Often a reliable vehicle is the most practical transportation mode to get to work. Car ownership increases the likelihood of being employed, maintaining that employment and at a higher wage. Additional products and services provide financial stability and anchor our credit union as their primary financial institution with lesser costs than alternative products such as buy-here pay-here auto lots. If we are able to take a chance on our member, they will remain loyal to us well into the future."
