By Gary W. Irvin, CCUE, CCE
Today's headlines are all about the fall of subprime lending, especially mortgage lending. But there have also been stories about disastrous subprime auto lending specifically in credit unions. I believe most of these involve third parties.
So you might be surprised that I am here to explain why subprime automobile lending could be a beneficial service for both you and your membership.
No, we are not crazy, but we are willing to leverage our competencies in the areas of lending and technology to serve a market niche. It is hard enough to find niches, let alone serve them effectively, so when we hit on a winning formula we feel compelled to share it for the benefit of our credit union friends.
Why, subprime auto lending? Here are four reasons:
- Reach more members.
- Our credit union was declining auto loan requests for members who appeared to have been on the path to rebuild derogatory credit. The desire was to serve this group in an effort to help them on their road to recovery … as most of these applications originated from the indirect lending channel.
- Better serve existing members.
- Some of the loan applications we were declining came from existing members in all delivery channels. The branch network and call center were expressing concern that we were unable to serve these members with some type of auto loan and that, by not serving them, they were receiving rates as high as 21 percent on auto loans.
- Increase indirect business (including prime business).
- Many of the franchise auto dealerships (one owner–multiple locations) were requesting that FORUM expand its offering into the subprime auto lending area, as they wanted to do business with institutions that offered both prime and subprime. The message was clear from the dealerships: "If you want more prime business, you are going to have to take some of our subprime business."
- Strengthen loan yields.
- With declining net interest margins and a flat yield curve placing pressure on the credit union's bottom line, a higher yield on this segment of loans was appealing.
The word subprime can mean different things to different people. So I should pause a moment to define what subprime means at FORUM, especially since some people call our program mid-prime, instead of subprime.
Probably the best baseline is to define the program by FICO ranges. FORUM serves consumers with a FICO score above 500 (looking at primary applicant score only). However, FICO is not the only factor in the loan decision. Therefore, a member with a 700 score could potentially qualify for a subprime auto loan if, for example, he or she had a recent bankruptcy and high debt or limited credit. Roughly 80 percent of FORUM's subprime loans fall in a score range of 551-700. The highest percentage of loans (33 percent) is in the 601-650 score range.
It should be noted that we have been offering subprime auto loans since 2005. One of the first items we researched when considering entering this market was the expected loss ratios compared to the interest income earned. It was evident from our research that self-insurance was not an option for us; we wanted the protection that third-party insurance would provide.
So FORUM researched potential partners for assistance in subprime underwriting and, most importantly, default risk insurance. After investigating options, we chose Capital Lending Strategies as our partner. Capital Lending Strategies assists with default insurance and a subprime auto lending scorecard, which takes FICO score and other factors into account. However, control over decisioning and the rest of the lending process appropriately resides with the credit union.
As with all of our products and services, we calculate and measure the profitability to be sure we are maximizing return for all our members, not just the ones that are using this particular service. The subprime auto lending portfolio ($28 million) is profitable and positively contributing to the health of the credit union.
For years our mantra has been "our best investment is a loan to our members." This subprime auto lending program fulfills this mission. The effectiveness of the program is a reflection of our competencies in the area of lending and technology as these competencies have created a win-win for both the members and the credit union. This product offering also fulfills a social mission of reaching out to others who may have fallen on hard times so that when things do turn around for them, we have a member-owner for life.
Want the nitty-gritty details? Please check out "Credit Union Subprime Lending" blueprint from FORUM Solutions, our CUSO.
Gary W. Irvin, CCUE, CCE, is president/CEO of $1 billion FORUM Credit Union, Indianapolis.
Read another post about lending from FORUM CU's Doug True.
Also read "Of Starfish and Subprime Mortgages."
