The ranks of the underbanked and unbanked grew considerably during the Great Recession, when the megabanks severely tightened access to credit for many who most needed it.
Five years into the recovery, many of the people who fell out of the traditional banking system have yet to return. That’s a signal that despite the best efforts of some sectors of the financial services industry–including many credit unions who take to heart the mission of providing access to the nonwealthy–huge swaths of the population don’t fall into the sweet spot of most lending strategies.
Whether that’s risk avoidance at play or a cost-effectiveness quandary tracing to the limitations posed by increased regulation in the Consumer Financial Protection Bureau (CFPB) era, many financial institutions are missing the boat.
Not because of a moral obligation to lend to subprime or nonprime consumers. Rather, because strict A&B-paper lending provides very thin margins and by properly lending to C, D and E paper borrowers you can significantly increase your bottom line. This is often the difference between a credit union with high growth and one that is stagnant or shrinking. These loan tiers also provide a way to differentiate your financial institution — no small matter when many traditional lenders have all but ceded the subprime territory to fintech startups.
According to recent statistics cited by CUNA Mutual Group at its online Discovery Conference session on subprime auto lending, 56% of consumers fall into that classification. And as many niche lenders at the recent Money 20/20 conference in Las Vegas pointed out, sizable segments of this group landed there only as the result of the financial crisis — either because of circumstances that sank their credit rating, or because they got scared off from traditional banking relationships and their spotty credit history works against them.
Let’s not delude ourselves: The risks presented by nonprime, subprime, and deep subprime are real. So if you want to issue C, D, and E paper loans, be advised to take steps to mitigate risk.
Robust data analytics program. Indispensable in general, an intensive, single platform data analytics platform is particularly crucial when servicing this sector. Not only should you gather every possible bit of information about the prospective borrower’s credit profile to accurately assess creditworthiness, you need to continually update and monitor all aspect of their financial behavior. That helps you both intercede with individuals when signs of delinquency emerge, and determining more broadly whether your underwriting and controls are effective.
Risk-based pricing. Serving members equally doesn’t mean charging them equally. Credit unions must hedge risk when issuing loans to consumers with suspect credit histories by adjusting the interest rate and repayment terms of loans. Adjust pricing structures based on your institution’s philosophy, industry standards and the statistical models you’ll begin to accrue by member repayment patterns.
Loan insurance products. Provide reassurance to members and to your profitability by offering subprime borrowers insurance that backs up their loan in the event of major life occurrences such as job loss or injury.
Analyze non-traditional credit metrics. To often in an underwriters tool belt the credit score is the key tool in a credit decision. By focusing on other metrics that also insure repayment, lenders can have confidence that riskier loans will be repaid. Try focusing on the following:
- Job Stability
- On time payments made to your institution in the past
- Require automatic payroll deduction for the payment
- Collect aggressively
- Ensure the loan is collateralized. Auto loans are a great place to begin this practice.
- Look at what type of loans the borrower has struggled with in the past. (Just because they defaulted on their credit card doesn’t mean they won’t pay to keep their nice car)
360-degree borrower profile. Generally speaking, people don’t go bankrupt all at once; they let payback plans slip one at a time. The key to serving this market is keeping your loan at — or toward — the top of their repayment priority list.
Credit builder products and financial education initiatives. Consider this a complementary piece to the loan insurance product — an aspirational tool that provides a pathway to better credit for people with good intentions who’ve been branded with poor credit ratings. Offering these products and classes attracts more business but also improves the quality of that business.
Balanced portfolio. Maintaining a balanced portfolio in all sectors offers a level of assurance that you can continue to serve a large and potentially profitable segment of your membership without suffering through politically compromising financial troughs.