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Southwest Lending Conference: Lower-Score Auto Loans—Good for Members and the Bottom Line
Thursday, May 19, 2016 6:25 AM

At Cornerstone's Southwest Lending Conference this week in Oklahoma City, National Credit Union Foundation Senior Program Manager Mark Lynch tackled non-prime lending. He kicked things off by asking what issues people face if they don't have a vehicle for transportation.

In cities all across the country, upwards of 86 percent of the population—and 100 percent in some cities—require a vehicle to get to work. Without it, life can be extremely difficult. If your credit rating is below 640, the general rate at which non-prime lending begins, life is even harder.

The average credit score of Americans—55 percent of the population—is below 640, the point at which nonprime lending comes into play. Credit unions have 5 percent of the nonprime market, which consists of people of modest means, low wealth, or underserved—the terms inherent to the credit union mission.

One big impact of the economic crisis, Lynch reports, is that families now pay their auto loans first, before their rent or mortgage, which is the opposite of what they did before the Great Recession. The personal auto has become the highest-value item, enabling people to get to their jobs so they can continue to earn for their families. The risk that they will default on their loans has decreased since they're more likely to pay that debt first.

Most credit unions are not making loans in large numbers to these people. But every time a credit union member is denied an auto loan, that member has little alternative than to use an alternative nonprime or subprime lender, which in turn can be riskier for the credit union due to the higher payments the member will then have to make and the higher risk of default.

The challenge facing credit unions is how they can do nonprime loans for members with low or no credit at a better interest rate than subprime lenders and in a way that does not place the credit union at risk. Lynch stresses that credit unions are missing out on a great opportunity because many people with low or no credit scores have not mismanaged their finances in the past and most likely won't in the future.

He says the top five reasons for bankruptcy are:

  1. Medical expenses (42 percent)
  2. Job loss (22 percent)
  3. Poor or excess use of credit (15 percent)
  4. Divorce or separation (8 percent)
  5. Unexpected disaster (7 percent)

Credit unions captured 17.6 percent of the auto loan market in 2015 (24 percent of the used auto loan market and 10.1 percent of the new car market). Credit union used auto loan market share increased by 2.1 percent, while new car auto loan market share decreased by 8.7 percent.

If your credit union could generate income of 10 percent on part of your auto loan portfolio, Lynch asks, would you be interested? He is adamant that nonprime used auto lending is a financially viable line of business. Why?

  • Serving the underserved involves nonprime auto lending;
  • Traditional pricing strategies prevent many credit unions from serving this group;
  • Credit unions need to lend to this group and price according to risk; and
  • It can be done in a financially viable way while saving the member money.

Lynch was part of a two-year pilot program with ten credit unions including University Federal Credit Union in Austin. University FCU has been doing this for 15-20 years successfully and shares their pricing and record of success; they have no indirect loans. At the end of the pilot program, these were the results of the ten credit unions' efforts:

  • 7,605 loans
  • Total loan dollars: $101,027,000
  • Average loan: $12,058
  • Average loan term: 53 months
  • Average age of member: 37
  • Average credit score: 585
  • Interest rate 11.7 percent
  • $3.7 million net income generated

The study demonstrated that by getting the pricing right and managing risk structure, these loans made a lot of money for the credit unions. Some things credit unions can do to get to "yes" for their members includes having a system in place to:

  • Get in front of dealers by assisting members in finding cars;
  • Employ a "credit union close" to cement bonds with members (loan details, heart-to-heart about responsibility for repayment, the credit union difference via member ownership, getting commitment of borrower to be proactive in the event of problems);
  • Insure borrowers against events out of their control;
  • Offer member incentives to make loan repayments on time;
  • Keep in touch with borrowers by allocating resources to monitor and collect loans at first sign of trouble.
  • Consider the use of GPS or system interruption devices.

So, how can your credit union work out a way to say yes to your low-wealth and underserved members?