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In the past, only the largest credit unions concerned themselves with credit risk management, says Steve Miller, CPA, director of operations at TwentyTwenty Analytics, a CUNA Strategic Services alliance provider.
That has changed.
“Now,” Miller says, “any credit union that’s not doing credit risk management faces risks—either criticism from regulators or danger to the bottom line from loans it didn’t properly assess for risk.”
Fortunately, he says, credit unions now have tools that can provide timely and accurate measurements of risk that allow them to quickly assess how well their loans are performing.
“Also, over the past few years we’ve seen a trend where the costs are actually decreasing as the credit bureaus and other companies that provide risk-related data are competing for your business.”
Trevor Carone, Experian’s vice president, portfolio and collection solutions, agrees that today’s lending environment has changed dramatically. “Nobody wants to repeat what happened a few years ago,” he says. “Credit union leaders have issued clear directives to their staff: Comply with all new regulations and improve the accuracy and predictability of your credit risk assessment procedures—or don’t lend.”
As a result, most credit unions are now bifurcating their portfolios, Carone says, by quantifying stress. “They’re more vigorously pursuing internal and external lending markets, and they’re looking closely at who’s still in financial stress.
“For example,” he says, “if a member’s monthly minimum debt payments suddenly go from $300 to $800, you can tell the person is under some sort of stress and has stepped up expenditures. If there hasn’t been a corresponding increase in income, that’s another sign.”
Credit unions’ ability to detect tell-tale signs of financial stress comes from the recent practice of examining both traditional credit scores and other information, Carone says.
“Where many lenders once depended on members’ FICO scores alone, they’re now looking at income, other loans, those loans’ interest rates, the total owed, monthly payment amount, and the percentage of the total available credit they’ve used. From there, they can divide members into high-, medium-, and low-risk segments, and then design loans for each.”
Experian recently introduced Total Annual Plastic Spend (TAPS), a solution that quantifies the last 12 months of consumers’ credit card spending.
When combined with income and balances, “it provides a quick way to assess their spending habits and ability to handle debt,” Carone explains. “For example, members who spend very little are more likely to need smaller credit lines, regardless of how low a risk they may be.”
Miller also agrees the credit score isn’t the end-all, be-all to lending it may have been.
“You can make a loan to a member who has a solid 720 FICO score and six months later he’s bankrupt,” he says. “So the score by itself doesn’t always tell you everything you need to know.
“Look at credit bureau reports, members’ share account histories, and, if possible, their overall FICO trends over time,” Miller continues. “The object is to structure loans to lessen risk.”
Another risk is one credit unions pose to themselves.
“They’re somewhat reluctant to raise loan rates because they tend to view all loans the same, and they’re inclined to have a single rate for all loan product types regardless of the risk,” Miller says. “But loan rates and terms should be based on risk. If not, credit unions are supplementing the higher-risk loan products through lower-risk members, and are cheating those lower-risk members and the credit union’s profitability.”
He estimates 5% to 6% of all credit union loans account for 80% to 90% of all losses. “Knowing which loans comprise this 5% to 6% of the portfolio can help credit unions focus their energy where they can get the highest return from their collection department with the least amount of effort.”
Those savings are initially what pay for good credit risk management.
“It’s not a burden because a better understanding of how to price loans produces a net gain versus net costs,” Miller says. “The cost of outsourcing credit risk management makes sense when you realize that having an employee work on a risk management project for six weeks when he or she could have been doing something else will cost more in the long run than having a service provider do the same thing in a much shorter time.”
Miller sees a great opportunity for credit unions during the next few years.
“As we come out of recession, big financial institutions are continuing to use regimented checklist criteria and are only pursuing the higher-tier loan prospects. Because credit unions are more flexible, they can pursue higher-risk prospects which, if managed properly, return a higher interest-rate premium.
“There’s a tremendous demand out there for loans,” he continues. “The key is to lend intelligently and understand the risks—and do it before the big financial institutions see the opportunity themselves.”