Thanks to improving consumer credit and pent-up demand for durable goods such as vehicles and appliances — not to mention a brightening purchase mortgage environment — many economists forecast double-digit loan growth again in 2015.
That’s fantastic news for the many credit unions and banks who rely on lending as their lifeblood, and view a more robust loan portfolio as the pathway to firmer footing in the aftermath of the Great Recession.
But to realize the full promise of this rosy lending forecast, financial institutions must maximize efficiencies in their lending operations, which have been subject to decreasing margins in recent years — primarily due to rising servicing costs and an overemphasis on competing on rates within the pool of the most reliable borrowers.
The recent explosion of available data, combined with tools that can slice and dice that information to a degree unimaginable a decade ago, make possible comprehensive, ongoing analysis that can address flaws and capitalize on strengths in every aspect of your organization’s approach.
Committing to constant refinement is crucial, because not only are your traditional competitors in the lending space honing data analysis to streamline their operations, a host of nontraditional, tech-savvy entities figure to enter this lucrative market in coming years.
Uncertainty restricts growth
A series of market events, aggressive regulatory escalation and Congressional scrutiny has added significant complexity to the lending process and prompted many financial institutions to become more conservative.
The collapse of the subprime mortgage market triggered the recession, and many analysts fear subprime auto loans are the next bubble waiting to burst. The Consumer Finance Protection Bureau continues to be highly active, instituting TILA-RESPA integrated disclosures effective Aug. 1 and formulating a new risk-based capital plan for credit unions. And the rising cost and level of outstanding student loans–now at $1.1 trillion–continues to be a focal point on Capitol Hill.
These forces collaborate to create significant uncertainty for credit unions and community banks that wish to expand their lending into more risky but potentially more profitable C, D and even E Tier loans, or into promising unbanked or underbanked segments of demographic groups such as Millennials and Hispanics that might lack credit history, making it difficult to gauge their ability to pay.
Augment a traditional tool
Credit scores have entered the mainstream, as the basis for many television commercials and advertising campaigns related to creditworthiness but also identity theft. They’re a pillar of the underwriting process, along with loan-to-value, debt-to-income, and other key factors. But they remain misunderstood even within some of the financial institutions that rely on them.
Too often, credit scores are treated as a definitive assessment of a prospective borrower rather than a forecast for their two-year default probability — a forecast that can change the following day, should a major life event occur. Also, credit scores reflect the statistical likelihood of default, not the severity of that default. A small loss carries as much weight as a significant loss.
Projecting this out further, credit score at loan origination is in many cases the key factor upon which financial institutions make decisions about handling of the loan throughout its lifespan. It becomes a static baseline that doesn’t reflect current conditions.
A clearer view
On the other hand, collecting and analyzing in ongoing fashion a multitude of factors and characteristics — perhaps some specific to your market, field of membership or mission — challenges your assumptions, allowing you to make more informed, actionable assessments of individual loans. It enables real-time reaction on existing loans and modification of everything from underwriting practices to cross-selling existing clients to the targeting of prospective borrowers.
At the macro level, optimizing portfolio analysis enables your financial institution to hone in on potential growth opportunities while identifying trouble spots. For instance, outstanding performance in one channel can mask festering problems within a certain segment of that market. Perhaps an individual auto dealer demonstrates unusually high delinquency rates in a given loan class, or among a certain vintage of used-car loans. That’s a situation you’ll want to investigate more thoroughly and correct.
Also, don’t overlook the opportunity to minimize compliance costs through greater efficiency. Examinations have become more complex, and the ability to produce detailed, organized documentation of your lending operations preserves staff resources while reducing scrutiny from examiners. And the ability to self-evaluate in areas such as concentration risk and self-regulate on complex issues such as disparate impact cannot be underestimated.