If you’re a credit union involved in Indirect lending, you’ve probably been following the news about the CFPB and their recent guidance on rate markups. In March, they wrote four of the big banks questioning their rate markup practices (allowing the dealer to increase the rate offered the consumer, and thereby increasing the amount paid to the dealer), and claiming that rate markups were likely to disparately impact (translation, illegal lending discrimination) protected classes under the Equal Credit Opportunity Act (ECOA). In April, the CFPB recommended that lenders engage in self-testing to determine whether higher rates were being charged to groups protected under ECOA.
Here is a recent article on F&I Magazine’s website, an interview with two noted attorneys whose practice revolves around auto dealers, detailing their thoughts on the CFPB’s “attack” on rate markups and dealer finance income.
While their perspectives are interesting, notice that they didn’t make a single mention that the CFPB is not trying to regulate dealers. They have no regulatory powers over dealers. They do, however, have regulatory powers for banks over $10 billion, along with non-bank lenders. Their power to take legal action and ultimately force a large financial settlement with lenders is immense. They also have the ability to make changes in existing regulations, like Reg Z. The CFPB is also reportedly looking at dealer sold insurance products, which increasingly are being structured to be non-refundable by the customer. The CFPB could potentially make ancillary products like warranties that aren’t refundable, part of the finance charge calculation under Reg Z.
As credit unions, we shouldn’t be afflicted with a similar “head in the sand” approach to potential changes like this in the industry. Whether you’re an Indirect or a Direct lender, or whether you allow rate markups or not, it’s important to understand the potential changes in the industry and how that might change the competitive landscape for all of us including our members.
Bill Vogeney is Senior Vice President and Chief Lending Officer for Ent Federal Credit Union, Colorado Springs
Part 6: The value of score migration analysis
As an introduction, I was inspired to write this article for my series on portfolio management due to a post several months ago on the List Serve. A member of the lending council asked about FICO score migration and the NCUA, and I felt the need to give my unabashed opinion. I could call this article, “(almost) everything you wanted to know about Score Migration, but were afraid to ask.” Here is my response with some editing.
I'll go out on a limb, and I'll state that the NCUA keeps bringing this up to credit unions for a variety of reasons. One of them is to see if they get an intelligent response. "Yes, we're doing it, and here are the results." "No, we're not doing it, because we don't know anything about score migration." Or, "No, we're not doing it, and here's why....."
I personally think answers one and three are acceptable. Number two probably isn't. In a nutshell, there are micro and macro benefits to score migration. From a macro level standpoint, score migration can quantify how your borrowers are responding to changes in the economy; for example, how many members are now scoring at extremely low levels due to loss of job, over-indebtedness, etc. But how much of a shift is significant? And more importantly, do you have reliable data on your portfolio at origination? As I have said many times over the years, there is no book you can buy (that I know of) that can teach you how to do score migration analysis. I can tell you that in the middle of “The Great Recession,” my own score migration analysis on our home equity and first mortgage portfolio basically showed that about 2.5 to 3% of the portfolio had shifted to a level of sub-prime credit, below a 620 FICO score, in comparison to our distribution by score at loan origination.
Whether you have the score information at origination or not, I think the key to score migration is doing a score migration once a year and developing a trend line. I have heard of credit unions getting updated scores quarterly on their entire portfolio, which I personally believe is overkill unless you have significant credit quality issues. If that’s the case, you may have other more pressing needs than doing quarterly score migration analysis. Once you have a trend line, you can use that to make risk parameter adjustments like changing your FICO score distribution goal (by making more or fewer B, C and D loans) or altering LTV guidelines. Going back to Ent’s score migration history, what meaning does that 2.5 to 3% shift in scores really mean? While we certainly saw losses rise along with our provision for loan loss expense, our financials escaped relatively unscathed. My belief is that the more your credit score distribution at origination is weighed towards near prime (620-660) and sub-prime (below 620), your portfolio will see a bigger shift downward in scores during an economic downturn.
From a micro perspective, there is also some potential value from the loan level results of a score migration analysis. In theory, borrowers who have seen a dramatic decline in their score should be among the first people to call if their loan becomes delinquent. In reality, the real impact on your management of the portfolio may be limited with score migration. If you have a car loan or a mortgage with a member, are you going to accelerate the collection process if the borrower now scores 580? Maybe not, if you can’t re-prioritize your collection queues based on an updated score. However, updated scores are a must for reviewing HELOC and unsecured lines. Are you shutting down lines when needed? That's half the battle-making line decisions based on new credit information.
If you’re feeling REALLY frisky on your first attempt at Score Migration, you could estimate the impact to the next 12 months of losses based on changes in your distribution. For example, if your score validation indicates that you now have twice as many borrowers below a 600 FICO score than you had at origination, you could in essence plug in your loss ratios, per tier, for your new score distribution. By doing this, you’re doing a new weighted average. For example, let’s assume that your credit union only makes car loans, and that at origination, your score distribution was 25% A, 25% B, 25% C, and 25% D. Your last 12-month loss ratios per tier have been .25% for A, 1% for B, 3% for C and 5% for D. Your rescoring now indicates the portfolio distribution is 20%, 25%, 25% and 30%, respectively. Let’s see what some simplified calculations could look like:
Current loss ratios New Score distribution
Tier Distribution Ratio Weighted Average Distribution Ratio Weighted Average
A 25% .25% .0625% 20% .25% .05%
B 25% 1.00% .25% 25% 1.00% .25%
C 25% 3.00% .75% 25% 3.00% .75%
D 25% 5.00% 1.25% 30% 5.00% 1.50%
Total loss ratios 2.3125% 2.55%
As you can see, the downward shift in the portfolio can be used to forecast future losses by using the new distribution and your historical loss ratios. You could also utilize the account management FICO odds chart to potentially do something similar based on FICO’s predictions of default on existing accounts based on the new score, compared to the predicted default rate at origination using your original score distribution. That would be a slightly more difficult analysis but certainly achievable if you were curious.
Quite honesty, while you could do this forecasting, my past experience tells me that in an economic downturn, the decline in overall credit worthiness of your members probably takes a back seat to additional exposure from issues such as:
If you’re tracking most of the key metrics I identified in my last few articles on the loan portfolio management “dashboard”, and you can illustrate specifically the impact on changes in those metrics, I doubt your examiners are going to demand score migration analysis.
Bill Vogeney is Executive Vice President and Chief Lending Officer for Ent Federal Credit Union, Colorado Springs. He can be reached at email@example.com
Credit union executives struggle to determine the proper amount that needs to be set aside in their Allowances for Loan and Lease Losses (ALLL).
The Office of the Comptroller of the Currency has issued a series of policy statements intended to guide financial institutions in the calculation of the Reserve for Loan Losses consistent with GAAP. The most recent policy statement, published in 2006, identifies credit unions and the NCUA as subject to its provisions.
In this policy statement, two specific directives are included that address calculation of the reserve for individually identified loans. They state:
Thompson Consulting and Training (TCT) recently initiated a longitudinal study to quantify the probability of actual loss for loans that become 60 or more days delinquent. Loan data from client credit unions is gathered monthly. The study so far has covered a time period of several years. The study is ongoing. As with any ongoing study, findings may vary over time. But, here is what has been observed to date:
From this study and other research, TCT concludes that an empirical, statistically validated credit migration model which includes a reporting system that identifies loans (individually and categorically) that are experiencing declining FICO scores will significantly contribute to:
Dennis Child is a 40-year veteran credit union CEO recently retired and has been associated with Boise, Idaho-based Thompson Consulting and Training for 25 years. Contact him at 435-770-0178 or firstname.lastname@example.org.
For someone in need of quick cash, a payday loan can look like a way to avoid asking loved ones for help or getting into long-term debt. But these loans usually prove unaffordable, leaving borrowers in debt for an average of five months.
Why borrowers choose payday loans, how they ultimately repay the loans, and how they feel about their experiences are the subjects of a new report from the Safe Small-Dollar Loans Research Project of the Pew Charitable Trusts.
Key findings show that:
* About 58% of payday loan borrowers have trouble meeting monthly expenses at least half the time. These borrowers are dealing with persistent cash shortfalls rather than temporary emergencies.
* Only 14% of borrowers can afford enough from their monthly budgets to repay an average payday loan.
The average borrower can afford to pay $50 every two weeks to a payday lender—similar to the fee for renewing a typical payday or deposit advance loan—but few can afford to pay off the full amount. This averages more than $400 on these nonamortizing loans. And 76% of borrowers renew or reborrow rather than repay their loans in full. Loan loss rates are only 3%.
* Unrealistic expectations and desperation lead borrowers to use payday loans.
Borrowers perceive the loans to be a reasonable short-term choice but express surprise and frustration at how long it takes to pay them back. About 78% of borrowers say they rely on lenders for accurate information. But the stated price tag for an average $375, two-week loan bears little resemblance to the actual cost of more than $500 during the five months of debt the average user experiences.
Desperation also influences the choice of 37% of borrowers who say they’ve been in such a difficult financial situation that they’d take a payday loan on any terms offered.
* Overdraft risk is common. Although payday loan sales representatives present these products as alternatives to overdrafts, most payday borrowers end up paying fees for both.
More than half of payday loan borrowers incurred overdrafts in the past year, and 27% report the overdrafts were because a payday lender made a withdrawal from their account.
* About 41% of borrowers needed cash to pay off a payday loan.
To finally pay off the loans, many of these borrowers ultimately turn to the same options they could have used originally—getting help from friends or family, selling or pawning personal possessions, taking out another type of loan, or using a tax refund to avoid taking out a payday loan.
* A majority of borrowers say payday loans take advantage of them, but most borrowers also say these loans provide relief. For customers who urgently needed cash, the friendly service they received at the payday loan outlets conflicts with their feelings of dismay about high costs and lengthy indebtedness.
Margin compression caused in part by lowering auto loan rates just to stay competitive has left most credit unions with little choice but to "reinvent" the auto loan process to cut costs.
That is the opinion of Sandy Weil, group vice president, strategic products group from Oracle Financial Services global business unit. He said interest in speeding up the auto lending process and cutting costs is forefront in the minds of many financial institutions.
"All financial institutions, including credit unions, are working to re-invent the auto lending process, focusing on stronger risk management, more disciplined pricing and greater automated efficiencies," said Weil. "Enterprise lending solutions supporting the full life-cycle of the lending process-origination through servicing and collections-along with automated credit scoring can streamline lending operations."
An enterprise system supports the elimination of duplicate data entry and reduces credit union staff keystrokes, explained Weil. "Deploying better technology allows credit unions to process more loans with improved quality than a competitor that is not using automation."
Weil said automation not only lowers the average cost per auto loan and lease, it creates a consolidated analytical view of information. "Credit unions are analyzing their own data more actively-the member's financial situation and the collateral-to determine which loans need to be priced at a premium due to higher credit risk, which also retains the appropriate margins."
20%-25% Productivity Increase
Citing performance metrics from credit unions using Oracle's automated lending solution, Weil said auto-decisioning dramatically speeds credit decisions (within minutes), with credit unions seeing a 20% to 25% improvement in productivity for their underwriters and loan processers. "Some organizations utilize real-time data to enhance member service, including a customer self-service portal."
Better collection strategies supported by automation has seen Oracle clients reduce delinquencies and losses by 10% to 15%, noted Weil. "Auto lending, as we all know, is highly competitive," concluded Weil. "Credit unions are improving their origination systems and streamlining both the servicing and collection departments to remain in the game."
This article appeared at www.cujournal.com and is reprinted with permission.