In today's market of narrow yields, rampant competition, and rate-sensitive borrowers, accurate pricing has never been more critical. But if there's a single foolproof method for pricing products, it has yet to be discovered. That's because pricing is as much art as it is math, and even a seemingly straightforward formula of calculating costs and yields requires some subjective analysis.
Credit unions are currently of two minds about the role competition should play in pricing. Ignore what others are doing, some cooperatives say, and you risk losing market share. Pay too much attention to the competition, though, and you might slash rates so far that you end up losing money.
Sometimes competition isn't the issue at all; engagement is. In these cases, the solution might be a rewards-based pricing model that favors members who do the most business with the credit union. In fact, as credit unions experiment with different pricing strategies, about the only thing anyone seems to agree on is the need to free rates from the tyranny of the credit score, which many cooperatives believe inhibits lending opportunities without effectively mitigating risk.
"Any risk score by itself doesn't take into account a member with dings on his or her credit, but who also has a great capacity to make payments," says Steve VanSickler, chief lending officer of Silver State Schools Credit Union ($638M, Las Vegas, NV). "So why am I penalizing that member by giving a homogenized rate based on a score?"
Mark Allen, senior vice president and chief credit officer for Washington State Employees Credit Union ($1.9B, Olympia, WA), puts it even more bluntly. Too often, he says, "credit reports get in the way of the relationship we have with the member."
CU QUICK FACTS
WASHINGTON STATE EMPLOYEES CREDIT UNION
HQ: Olympia, WA
12-MO SHARE GROWTH: 6.12%
12-MO LOAN GROWTH: 19.67%
A Foundation For Nimble Pricing
Although Washington State Employees Credit Union (WSECU) is currently working on a proprietary plan to abandon credit scores, the credit union keeps an eagle eye on competitors to gauge pricing. This is particularly true when it comes to one of the industry's most competitive products — auto loans.
The credit union's strategy is straightforward: Lay the foundation for your institution to be nimble with pricing and then match or undercut your competitors for a larger slice of the pie.
WSECU laid the groundwork for this plan by selling off much of its mortgage portfolio to Fannie Mae several years ago and, as of last July, by changing its field of membership. The credit union currently has only short-term fixed-rate mortgages in its portfolio.
"That's given us pricing power that we wouldn't have had otherwise," Allen says.
By shedding all of its 30-year mortgages, WSECU was able to expand auto lending, where the reduced interest-rate risk permitted more pricing flexibility. Automating back-office functions also helped the cooperative compete better by driving down costs, while the new field of membership attracted more borrowers.
"Before, our membership made it difficult for dealers to figure out who was eligible to work with us," Allen says. "You had to be a state or government employee."
Now, anyone living or working in the state is eligible to join. As a result, the credit union doubled its membership growth from 2.5% to 5% last year. The new field of membership also had a profound effect on the cooperative's market share for auto loans, which jumped from 30% of it's previous market as of June 30 to 38% among its new membership base at year's end.
Aggressive pricing also helped.
"A few years ago, our pricing was in the middle, but today we're at the low end," Allen says. "We're not always the leader, but we're pretty close. "
When the credit union doesn't come close enough, it will match a competitor's rate rather than lose the member's business. A typical profit margin for WSECU's auto loans was around 1.5% in 2013.
Now the cooperative is about to ramp up the pressure on competitors by keeping closer tabs on pricing. Currently, a pricing committee establishes rates for auto and RV loans monthly using survey data the credit union gathers on competitors. The problem with that approach, Allen says, is you could be uncompetitive for up to 29 days a month.
Instead, the new strategy calls for surveying competition daily and adjusting prices accordingly, something the credit union already does for mortgage rates.
"We want to move that same responsiveness on pricing to auto lending this year," Allen says. "We have the system built and we've been monitoring this tool. It's just a question of having the committee be comfortable delegating authority to the lending team."
CU QUICK FACTS
Ent Federal Credit Union
HQ: Colorado Springs, CO
12-MO SHARE GROWTH: 3.30%
12-MO LOAN GROWTH: 9.64%
The Rate-Setting Formula
Competition has less influence over pricing at Ent Federal Credit Union ($3.9B, Colorado Springs, CO), where Bill Vogeney, senior vice president and chief lending officer, relies on a simple cost-benefits equation. Vogeney takes the amount of a considered rate reduction and divides it by the new rate minus all costs — including the cost of missing out on other investment opportunities — and the projected loan loss rate. The result is the percentage that loan volume needs to increase by in order for the new rate to be profitable.
Vogeney tested his formula several years ago when the credit union wanted to generate more unsecured personal loans. Ent doesn't offer credit cards, so it decided to emphasize personal loans or lines of credit instead. At the time, the credit union's best rate was 10%, but Vogeney wanted to be sure he could generate enough volume with the new rate to compensate for the lower yield.
Credit unions can certainly increase loan volume by lowering rates, but the real question is whether they're improving their net interest margins, Vogeney says. "Why make more loans if you're going to make less money?"
After plugging in his numbers, Vogeney settled on a new rate of 7.55%. Still, his formula told him he would need to generate 52% more loans for the rate to be profitable, which he thought was doable.
Before the rate change, the credit union had been making approximately $600,000 in personal loans a month. After the change, it made $2.5 million the first month alone.
Vogeney's formula also discourages money-losing decisions, including the kind that local competitors driving down rates can provoke. For example, on one occasion, a competitor was offering an unsecured loan at a phenomenal rate of 4.99% for 60 months.
"I immediately started squawking about it in meetings, saying ‘Are we going to match that rate?'" recalls Vogeney, who answered his own question after some quick calculations. "The model said I needed to increase volume 80%."
Vogeney didn't think the increase was possible when Ent was still making about $2.5 million in personal loans each month. He also knew some existing borrowers would ask for the new lower rate. Plus, with many borrowers feeling overextended, no rate is enticing enough to keep credit unions from eventually running into a brick wall.
"There's a finite demand, and we have too much money chasing not enough loans," says Vogeney, who decided to pass on matching the rate.
Ultimately, Ent's formula relies on good judgment and discipline. Whether a cooperative is likely to generate the necessary increase in loan volume is entirely subjective, so credit unions must be prepared to take action if they guess wrong.
If you lower prices but you don't get the volume you need, you've got to have the discipline to increase rates.
"If you lower prices but you don't get the volume you need, you've got to have the discipline to increase rates," Vogeney says, which is something some credit unions might be too fearful to do.
And because every pricing decision can trigger a chain reaction, such as a competitor matching the rate and depressing anticipated loan volume, Ent is always revisiting its analysis with new numbers that can point toward a different outcome.
A Matrix That Downplays Credit Scores
Pricing loans is really about pricing risk, but credit scores alone can be misleading, hurting the otherwise worthy borrowers that credit unions are supposed to serve.
That's why Steve VanSickler, the chief lending officer of Silver State Schools Credit Union, devised a matrix that prices risk in a more nuanced way.
In addition to standard credit scores, his pricing model also considers other attributes such as loan-to-value and debt-to-income ratios as well as the borrower's ability to absorb a shorter term.
CU QUICK FACTS
SILVER STATE SCHOOLS CREDIT UNION
HQ: Las Vegas, NV
ASSETS: $638 M
12-MO SHARE GROWTH: 0.10%
12-MO LOAN GROWTH: -12.84%
Because each attribute is weighted equally, a borrower with a lower-tier credit score who ranks high in other areas can still qualify for a top-tier rate.
"That person may get priced just as well as an A-tier borrower who has a higher debt-to-income or loan-to-value ratio with a longer term," VanSickler says. "It's a more accurate way of pricing risk because it considers income stability and the cash flow needed to make payments."
Consider, for instance, the credit union's matrix for direct auto loans. The lowest credit tier has no minimum credit score for borrowers, only a maximum of 639, something that initially worried board members. But the category also produces an average weighted yield of 14.23%, almost twice the yield in the next highest tier where the top credit score is just 679.
To compensate for the absence of a credit floor in its lowest tier, Silver State's pricing model limits the maximum debt ratio for the category to 45%, compared to 55% for the top two levels. The maximum loan-to-value ratios also narrow from 125% for the highest tier to 90% for the lowest.
A critical pricing component is the loan term. Every credit tier gets half a percent knocked off the rate if the loan is for 48 months, with terms between 12 and 36 months discounted by 1%. That mitigates risk while providing an incentive for borrowers to repay sooner, which ultimately benefits Silver State Schools.
"If somebody goes with a shorter term, I can churn that loan faster and probably get a higher rate in the future," VanSickler says.
The credit union uses similar pricing models for its other loan products, including credit cards, and tightens or loosens pricing according to soft credit data it pulls quarterly on all members with loans. That data helps the cooperative track score migration so it can set rates.
"We know if the credit in any given tier is weakening or improving and how many members have moved to a higher tier or deteriorated into a lower tier," VanSickler says.
Because the data also includes how much installment and revolving debt each member carries, Silver State can use the information to target certain individuals with exclusive promotions, such as a credit card with no balance transfer fee.
The pricing model's biggest advantage is its consistency and transparency, making it easier to follow for everyone from regulators to front-line staff.
"That was a problem in the past and the credit union suffered large losses because of it," VanSickler says. "Now everyone can see the types of loans we're making and all aspects of the risks."
CU QUICK FACTS
LOS ANGELES POLICE Federal credit union
HQ: Van Nuys, CA
12-MO SHARE GROWTH: 2.99%
12-MO LOAN GROWTH: 2.90%
Better Deals For Profitable Members
Two years ago, Los Angeles Police Federal Credit Union ($771M, Van Nuys, CA) analyzed the costs associated with certain accounts and turned up some disturbing evidence. Checking accounts with average balances of $250 or less were costing LAPFCU $600,000 a year to maintain. What's more, the credit union's business relied on just 40% of its members, who essentially supported the other disengaged 60%.
Something had to change, so LAPFCU created a rewards program to encourage more profitable behavior. Beginning in October 2012, LAPFCU began charging for checking accounts — at a cost of up to $4.99 per month — and waived the fee only for certain users. Members get free checking if they sign up for eStatements and direct deposit at least $250 monthly into the account. Individuals with a first mortgage are also exempt from the fee, as are credit card users who make at least two monthly transactions while receiving eStatements for both their checking and credit card accounts.
Rewards members receive other benefits too. These include a free box of checks annually, a 0.20% higher yield on certificates, and a 0.15% discount on consumer loan rates — with an additional 0.35% off for online applicants who sign up for automatic payment. The rewards program even rebates $200 in closing costs for a new first mortgage and up to $25 in ATM fees.
Currently, 32% of checking accounts at LAPFCU qualify for rewards, and the credit union has returned 73% of its fee income to loyal members in the form of rebates, rate discounts, or higher certificate yields.
Member behavior has changed significantly as a result of the new approach. From October 2012 through December 2013, credit card and checking accounts with only eStatements skyrocketed 46%. For every user that switched from paper to electronic statements, LAPFCU saved more than $2.49 per month for a total annual savings of about $30,000. Mortgage loan balances also rose 30% during the same period along with a 16% increase in credit card transactions. That growth occurred despite LAPFCU losing 626 members because of the new fees.
"We knew some of those accounts would go away," says Carol Martin, senior vice president of operations and member relations. "That was the goal — either become engaged or leave the credit union."
Overall, the program is responsible for making 42% of accounts profitable at year-end 2013, up slightly from just below 40% when the program began.
"Moving that number takes a lot of work," says Manny Padilla, Jr., LAPFCU's vice president of marketing. "It's like moving a boat to avoid an iceberg."
Nevertheless, he says, "The program has far exceeded our initial goals because we expected more resistance from members on the fees." If there's any lesson learned, he adds, it's that it never hurts to ask members to step up their business with the credit union.