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LENDING SOLUTIONS: Opportunities to Increase ROA

Date:

BY BOB SCHROEDER

What are top-performing credit unions doing differently when it comes to their ROA? It turns out they share a surprisingly long list of traits. Is your CU up to snuff in joining them at the pinnacle of your peers? A lending expert weighs in with strategies to take you to the summit.

I was asked to make a presentation at a Financial Executive Council meeting in April. I am always glad to get the work and was excited about the opportunity to present to a number of decision makers who hire consultants like me. The event planner wanted my presentation to focus on increasing ROA, specifically through lending opportunities and pricing strategies. I added a brief section on other income, because this is a critical component of ROA in today’s environment. When I was asked to write this article, I thought I would share some of the concepts.
In the current interest rate environment, many credit unions are struggling. Investment yields are below one percent, and declining loan yields are squeezing margins. However not all credit unions are suffering. I thought it would be interesting to look at the top- performing credit unions as measured by ROA.

Traits of Credit Unions with a Strong ROA
It is our experience that these credit unions have the following characteristics:
• Loan-to-share ratio of 90 percent or greater – These credit unions put their money to work in loans. Each $100,000 you take out of one percent investments and put into six percent loans generates $5,000 in revenue per year.
• Net loan yields (loan yields less charge-offs) higher than peers – Some are as high as of 7.5 percent.
• Other income to assets of two percent or greater – Other income is critical for credit unions with declining loans and/or loan yields. You can’t be a top performer without other income above your peers.
• Loan growth of 10 percent annually – Earnings will follow loans. Grow loans and you grow earnings. Declining loans will result in declining earnings.
• A large concentration of members with direct deposit
• Delinquencies and charge-offs higher than their peers
– Credit unions that take more risk have higher-than average delinquencies and charge-offs and also earn more income. Look at your credit union loan portfolio. You make a greater ROA on your unsecured loans with higher delinquency and charge-offs than you do on your real estate loans.
• Incentive plans for all staff – You need a strong sales culture to be a top-performing credit union. It will be difficult to establish a sales culture without a generous incentive plans for all staff members. We have specific plans that can be implemented at your credit union.
• Smaller-than-average loan balances – Mr. and Mrs. “A+” want a $40,000 loan for their Lexus. You offer 2.9 percent and they ask you to do the “limbo.” How low will you go? You settle at 1.99 percent for 60 months and your total finance charges are $2,056, assuming the loan is not paid off early. Take the same $40,000 and lend it for 48 months at 12 percent to four members who live on “D” street and earn $10,560 in finance charges, assuming no loan loss or prepayments. That is over five times the earnings in one less year.
Notice I did not include reducing expenses as a way to improve ROA. It may help for the short term; however, I was always concerned with the loss of revenue stream the expense reduction would cause. To improve ROA you need to increase loans, loan yields and other income. Let’s take a look at how to make this happen.

Philosophy
It all starts with our loan philosophy: “The only reason a member should ever be turned down is when we believe the credit union will not be repaid.” Note that it does not say past or present delinquencies with others, insufficient collateral or insufficient income, which are credit unions’ favorite reasons to turn down a loan.

Loan Policies
Loan policies need to be flexible enough to make loans when it makes sense to the member and the credit union. Focus on removing barriers to making loans. The following are common recommendations:
• Authorize the CEO and/or Vice President of Lending to make loans outside of the policy and report the details of the loan at the next scheduled board meeting.
• Use “guidelines” as opposed to “limits.” Limits are barriers to lending. When exceeding “guidelines,” have your loan officer document in the loan notes why he or she felt the credit union was going to be repaid. Guidelines work well with debt-to-income ratio, loan-to-value limitations, loan limits, term, etc.
• Unsecured loan limits need to be aggressive. We feel unsecured loans up to 25 percent of annual gross income are reasonable. If you agree and allow unsecured loans only to $25,000, then you do not want to be the only financial institution to those members making over $100,000 per year. Such individuals should be able to handle more than $25,000 in unsecured loans. Unsecured loans are one of your most profitable products. Push unsecured loans up to 20 percent of your loan portfolio.
• We are coaching clients on extending loan terms on car loans. LSCI recommends terms of up to 108 months or nine years. (No, this is not a typo.) This length will allow you to compete on payment and not give up yield. We recommend a one to 1.5 percent rate increase for
each year over 60 months. You can earn 4.6 times more income on a 108-month loan over a 60-month loan. You will earn $2,224 on a $30,000 loan for 60 months at 2.95 percent. In comparison, you earn $10,198 on a $30,000 loan for 108 months at 6.95 percent. Make sure you include a mileage analysis when extending loan terms. This is a great strategy to help both loan growth and loan yield. You get more loans with lower payments and increase yields with the higher rates on longer terms. You will set the trend because we predict this will
become the norm within the next few years. Check with your GAP and your credit life and disability providers to see product limitations on extended term loans. Do you currently finance 2009 cars for 48 months?
• Serve members who have caused you a loss! Not serving them is a barrier to lending. Many members file bankruptcy and cause you a loss but they may not know you took that loss. In Chapter 7 the bankruptcy declarer pays into the plan and the trustee repays the creditors. Hence, the member likely did not know you received only 10 cents on the dollar. If such a member caused you a $2,500 loss on a Visa card, you can easily make that up on a $15,000 auto loan at 15 percent. You will earn $6,410 in finance charges! With bankruptcy reform and risk-based lending, this policy statement needs to be removed.

Increasing Loans and Loan Yields
• You need to determine the member’s motivation for coming to you. Why us? Why now? Motivation is the key to serving members.
• Train your staff how to identify bankruptcy indicators and how to serve those members who are about to file bankruptcy. Bankruptcy indicators include excessive unsecured debt to AGI, many new accounts with balances, many inquiries, balances near limits and high debt-to-income ratio. I would guess if I were to walk into every credit union loan office in America and I were to tell them I was considering filing for bankruptcy, I would be denied 95 percent of the time. The other five percent who are well trained and the best of the best understand how to make loans that survive bankruptcy. How would your loan officers perform?
• Use the LSCI High Yield Lending Strategy or the HYLS scoring model to assist your staff in looking for loan opportunities and in identifying bankruptcy risk. HYLS reviews many critical components to lending that FICO does not. The FICO scoring model has no idea on underwriting ratios such as debt to income, unsecured debt to income, loan amount to income and loan to value. A person with $15,000 in unsecured debt is not a problem if he or she makes $80,000 per year. You have a big problem at $25,000 per year, yet these two individuals have the same FICO score. In addition, the FICO score underestimates accumulation of debt and the problems this causes. HYLS will let you know when you have a problem.
• Use credit score enhancement services to build loans. Review the member’s credit report with him or her and provide specific strategies on how to improve his or her score. Teach these members how much they can save in finance charges with a good score. When reviewing the credit report with the member, you should be able to come up with a better financial solution using your products and services.
• Train your loan officers to identify the trend in the credit score. If the credit score trend is moving up, you have a great yield and decreasing risk. It is unfortunate that many credit unions do not see this opportunity. If the credit score is going down, you get a low yield and increasing risk. Not a good combination. I would prefer to lend money to a 590 score moving up than a 710 score moving down.
• The value of interviewing skills is underestimated. We feel many loans are being turned down because of an inadequate interview. When reviewing loan denials at the credit unions I work with, I agree that most turndowns can’t be made. I also believe that such members should not be denied without getting the entire story. What was the motivation? What assets do they own? What is the equity position of the home and cars? Do they have any other income? Oftentimes, credit unions approve previous turndowns after conducting a thorough loan interview.
• Have your loan officers open new accounts. No one will be able to sell your loans better than your loan officer. Many credit unions use their member service or teller staff to open new accounts. When I review new accounts, I see many opportunities left on the table. The two best times to steal loan accounts is when the account is being opened and during a loan interview.

Pricing
“If you get the member by rate you will lose the member by rate.” Most credit unions will not be able to survive using a low-cost- provider business model. Having said that, I see many credit unions spend their marketing dollars advertising loan rates less than two percent. Our recommendations are:
• Make sure you have rate increases for older vehicles and higher loan-to-value ratios. We recommend a three percent increase in rates both on vehicles 2008 or older and loan to values in excess of 121 percent.
• I have seen credit unions reduce pricing for promotions that cost them a lot of money. An example is unsecured promotional rates at seven percent reduced three percent from 10 percent for a limited time period. In this example, you need a 50 percent increase in business to increase earnings.
Normal volume $1,000,000 at 10 percent generates $100,000.
20 Percent increase to $1,200,000 at seven percent generates $84,000.
30 Percent increase to $1,300,000 at seven percent generates $91,000.
40 Percent increase to $1,400,000 at seven percent generates $98,000.
50 Percent increase to $1,500,000 at seven percent generates $105,000.
Solution – Do not give everyone the special rate; use a coupon or code.

• Market solutions not rates. Use promotions such as “Debt happens, we have solutions” or credit score enhancement services.

• Closing the Beat Your Rate Deal: Offer the savings upfront if the member is not excited about the reduction in payment. Example:
• Offer one percent cash back instead of beating the rate by one percent.
Example: Loan amount of $25,000 with 58 months remaining at 4.5 percent
• Option 1 – One percent cash back, same 4.5 percent rate
$2,864 in finance charges at 4.5 percent if the loan is paid to term
– $250 one percent rebate / cash back $2,614
• Option 2 – Beat the rate by one percent, or 3.5 percent APR
$2,210 in finance charges at 3.5 percent if the loan is paid to term
• Do not require down payments and pick up extra earnings. Make sure your staff understands the cost of a down payment!

Lending Solutions

Option 2 generates 24 percent more earnings! The last $1,000 generated $424 in additional finance charges, or 19 percent APR (10 percent plus one percent extra on the first $9,000).

I love lending money at 19 percent APR! If the member will pay you $9,000, he or she most likely will pay you $10,000. If the member is a bankruptcy threat, you may need the down payment to make yourself bankruptcy proof.

Other Income
Members are demanding loan rates below our cost of operations. We have to make it somewhere. We recommend you target other income of two to three percent of assets. According to CUNA, the industry average is 1.32 percent. NSF and Courtesy Pay is a big revenue generator for nearly all credit unions. The following is what I see as opportunities to increase other income.
• Credit unions usually price GAP insurance between $250 and $350, while dealers price it at $700 to $1,100. Bump your price to $595, pay a nice incentive to your sales staff and watch your other income skyrocket.
• Mechanical repair coverage is a great opportunity for credit unions. When I was CEO, I struggled to get my team to sell this coverage until I hired a used car salesman as a lender. He sold over 50 percent and trained my other loan staff.
• Credit life and disability or payment protection is not sexy but the other income it can produce is. I have seen credit union reimbursement range from two percent to 40 percent. Negotiate a healthy reimbursement, pay a good incentive and boost your earnings.

Case study on ELGA Credit Union in Flint, Mich.:
• $407 million in assets
• Fee and other income to assets 3.23 percent
• Life and disability reimbursement for 2014 totaled $413,000.
• Life and disability claims for the year were $630,000.
• GAP profit after paying CUNA for the policy was $495,000.
• Over 75 GAP claims were paid out.
• Warranty income after paying CUNA was $30,000.
• 43 warranty claims for over $34,000 in covered repairs were paid.

According to Terry Katzur, ELGA’s Executive Vice President, the above income figures are net of costs, so it is bottom line income totaling nearly $1 million. He went on to say, “These are products that help their members protect their livelihoods and their credit. Without them we would see more members in financial distress. A 2013 Filene white paper polled members about which sources of NII they felt provided the greatest benefit to them (the credit union member) and 94.4 percent said GAP, 92.1 percent CL/CD and 84.4 percent mechanical repair coverage.” The times have changed. Have you? If you need help implementing new strategies to enhance your ROA, rest assured we are only a phone call away.

Bob Schroeder, vice president, consultant of Lending Solutions Consulting Inc. or LSCI, began his 30+-year credit union career in collections before moving on to lending. He has 11 years of experience with two of the largest credit unions in the country, rising to the level of vice president of credit before moving on to serve as CEO of a community credit union. During his 21-year tenure as CEO, the credit union experienced a period of rapid growth and strong earnings. Bob can be reached at bschroeder@rexcuadvice. com or (815) 761-0135.

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