In his book “Seeing What Others Don’t:The Remarkable Ways We Gain Insights,” author Gary Klein points out that while many organizations focus on reducing errors to increase performance, few focus on new insights. He argues that true performance improvement requires the opportunity for both.
As consumer lending remains highly competitive for lenders, simply avoiding risk is not a sustainable growth plan. Think about all of the loans that your credit union will not do, or fails to do. Just a fraction of those loan opportunities would offer sufficient loan growth to provide margins for increased profitability. Instead of working harder to get the hardest loans, perhaps new insights and strategies into how to capture more of the existing opportunities would pay larger dividends.
Frustrated By Guidelines And Restrictions?
A recent discussion with a credit union manager revealed frustration caused by a lending policy which prevented him from matching lower rates quoted to members at the point of sale. He describes the process: “A member who is pre-approved for an auto loan calls in from a dealership offering a rate that is 50 basis points below our rate. We will not rate match under any circumstances, so the member ends up financing at the dealership. After a couple of months pass, we try and recapture that loan, offering to beat the existing rate by 50 basis points. If the member agrees to the offer then they must apply again and get approved. So, at the end of the process, the member has applied twice for a loan and we have ended up losing 50 basis points.”
One can surmise that the credit union based its policy to not match lower rates on the premise that they are giving up interest income, and it would be difficult to manage the constant request to match rates. After all, at some point, one has to draw the line. But, if we were to look at this from an opportunity standpoint, how many times did the lender put themselves at risk of losing the member? By not initially matching the rate they would eventually offer the member, the credit union ran the risk of angering the member and losing the loan. Then later, when they offer the opportunity to refinance, they make the member re-apply for the loan. Ouch! Finally, without regard to the member in this scenario, how much time has the credit union wasted in taking two applications for the same member, only to give up more income than they would have in the first place?
Finally, think of all of the lending guidelines that your credit union has in place: debt-to-income, loan-to-value, time on job, time at residence, etc. Not to say these aren’t important risk attributes to consider, but do you know — for a fact — if the guidelines your credit union has set truly reduce losses or if they limit profitability and growth? In other words, is there a marked difference in performance between a borrower that has been on their job for six months vs. two years? Only an analysis of your credit union’s portfolio performance against these attributes can tell you for sure. What if your performance data revealed that members with a 580 credit score — who also meet a list of other criteria — never default? Could you do more loans?
More Than Loan Volume
In 2013, credit unions increased lending by almost 8% and managed to retain market share. But, in the same period, income from loans decreased almost 2%, while operating costs increased. The resulting impact saw a reduction in net income of just over 4%. But it’s not enough to do more loans; credit unions must also leverage higher consumer demand to increase value to the member owners. Capturing loans in a growing market isn’t that spectacular, especially if your strategy is to compete at the lowest rate and simply eliminate risk.
To be the type of lender that credit union members have grown to expect or demand, institutions must be willing to look for new lending opportunities, which may present new risks. While you may have eliminated some of the risks that cost you in the past, you may have also prevented some of your most profitable borrowers from doing business with you again. This is why ongoing loan portfolio risk management plays a big part in what successful credit unions are doing today. It’s essential to understand those risks, put controls in place to mitigate the risk of loss, monitor those controls to ensure that your assumptions are correct, and then price accordingly.
As we consider risk management and analytics, we need to consider both eliminating errors and increasing opportunities. This is difficult, unless you provide yourself with informative, real-time data that allows you to make better, faster, informed decisions.
(This is an excerpt from an article that will appear in the upcoming Summer ‘14 issue of CU Direct’s Credit Union Lending magazine)