A non-prime borrower is someone with a credit score below 700. Non-prime borrowers represent 42 percent of the entire U.S. population and it is estimated that $200 to $275 billion in vehicle loans were originated to them in 2003. However, a recent survey conducted by Lenders Protection, LLC showed that only 11 percent of credit unions are targeting this market. Credit unions should consider becoming more involved in non-prime lending because:
1.) It is a growing market.
2.) It can increase their loan yields.
3.) Non-prime lending falls within credit unions’ core mission.
A Big Opportunity
Between 1990 and 2003, U.S. non-prime vehicle lending grew from $20 billion in loan originations to $275 billion, but the origination market remains fragmented. Auto captives hold 32 percent of all these loans and the top ten banks in non-prime loan originations hold 14 percent of the rest of the market.
According to the survey mentioned above, credit unions only approve 46 percent of non-prime vehicle loan applications compared to 83 percent of prime vehicle loan applications. By judiciously increasing their risk appetite, credit unions could significantly increase their vehicle loan originations.
Boosting Loan Yields
Non-prime loans also generate juicier yields because of the higher risk that they entail. With the spread between loan yields and the cost of funds at its lowest point in ten years, credit unions could increase their yields by originating carefully vetted non-prime loans. While credit unions need to increase their risk tolerance to write these loans, they should also ensure that they have strong underwriting and modeling practices in place to deal with their unique characteristics, such as higher defaults and different prepayment patterns.
Several vendors have developed underwriting criteria and expected cash flow models that quantify the additional return earned in exchange for shouldering more risk. Credit unions considering a partnership with a vendor in non-prime lending should also consult the NCUA’s Risk Alert on Third Party Sub-Prime Indirect Lending and Participations. In the end, credit unions have the potential to increase interest income on a risk-adjusted basis with non-prime loans.
Serving All Members
Finally, credit unions can get involved in non-prime lending as part of their core mission to serve the underserved. Many of their members fall in the non-prime category and either cannot get a vehicle loan or can only get a loan with exorbitant rates and high down payments. By providing loans to these members at potentially more favorable terms that still compensate the credit union for higher risk, credit unions are meeting their members’ basic financial needs.