Many credit unions have moved to what they consider to be Risk Based Lending. Other credit unions are considering a move to Risk Based Lending.
Some have done so in order to market new lower rates to their A+ and A members and regain this loan volume. Other credit unions have done so to attract new members and fewer have done so to attract high yield C, D and E members.
The reality is that there is a significant difference between Risk Based Lending and Risk Based pricing:
Risk based pricing is when a credit union changes their rate structure to be competitive with the industry in attracting A+ and A members/customers. The outcome of a risk based pricing structure is determined greatly by your policy and core underwriting capabilities within your organization. Most of the time, credit unions leave their old style of underwriting in place and just replace their rate structure with one that allows them to "lend to everyone." With this model in place:
If you have primarily conservative loan officers, and you offer industry competitive pricing, you will see your portfolio mix migrate to more A+ and A paper and a declining yield.
If your loan staff is more liberal and you implement industry competitive rates you will see the addition of the A+ and A borrowers but may also see higher yield loans with escalating delinquency and charge-offs. The net impact will still be a lower effective portfolio yield.
With proper Risk Based Lending – instead of pricing and training for all lenders and collections staff, you will be able to establish a balanced portfolio that includes somewhere between 20% to 28% of the portfolio in the C, D and E credit categories. It is often a misconception that the most dangerous loan you can make is to a C, D or E borrower. The reality is that you will more likely suffer a loss from an A or B customer. With some A and more B customers you must determine if their credit is headed down or up. With C, D and E customers you already know who you are dealing with so you will structure your loan to these individuals so they have a meaningful equity position in the collateral. When lending to C, D and E customers you are structuring the transaction so it is on your terms and they have a reason to pay.
With A and B loans, you the credit union, will likely be upside down as soon as they take possession of the collateral.
CEO and part owner of CUSAG, LLC, John has extensive background in both the Commercial Banking world as well as the Credit Union Industry. John’s background in the Commercial Banking world was that of a Senior Executive for a 2.1 Billion Dollar Bank with responsibility for the commercial non-credit division as well as overall bank operations.
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