Why It’s Primetime For Subprime!

Increasing competition for A and B paper creates a subprime opportunity for credit unions – if priced properly and focused on member value.


Recent headlines in the fixed income market have been dominated by the risks associated with subprime mortgage loans. Mortgage lenders typically categorize prospective borrowers as Prime, Alt A (near prime), or Subprime based upon their credit worthiness. The subprime mortgage market is characterized by lending to lower income borrowers with higher levels of debt to income and weaker credit profiles (e.g. lower credit scores). In contrast, prime and Alt A borrowers will typically have a more solid credit history, debt to income ratio, and loan to value ratio (LTV).

What is happening?
Aggressive lending practices and the rise in “affordability” loans in recent years have led to a rapid expansion of the subprime market. This has resulted in a weaker credit profile for recently originated subprime loans which are now coming under increased stress due to declining home prices and payment shock from Adjustable Rate Mortgages (ARMs).

  • Delinquency rates on loans originated in 2006 are underperforming compared to prior issuance vintages
  • Lower rated subprime credit spreads have widened significantly
  • AAA-rated subprime credit spreads have been more resolute
  • Many subprime lenders have experienced significant losses and may be sold or forced into bankruptcy

Source: Credit Suisse

Credit Unions Should Not be Afraid of Subprime
The competition for A and B paper is increasing. In some cases credit unions may be making some loans at a rate lower than required to cover overhead When priced properly, subprime can add member value and provide the credit union a high yielding asset. However, knowing how to price subprime is key decision. Each credit union will have different default rates and recovery rates. A well-capitalized credit union could use the following model to help price loans until their actual data can be used.

Sample Pricing Model:
Cost of Funds: 2.46%
Overhead: 2.19%
Servicing 0.25%
“Hurdle” Rate 4.90%
Required ROA 0.85%

Credit Considerations:
  Default Recovery Add Rate
“A” Quality 1.20% 60% 0.48% 6.23%
“B” Quality 7.06% 45% 3.88% 9.63%
“C/D” Quality 24.72% 30% 17.30% 23.05%

Source: WesCorp, NCUA

The strategies in pricing loans are similar to those used in pricing deposits. A key fundamental in any pricing method is to not set your rates based on your competitors. If a competitor wants to lend C/D paper at a rate that far undercuts the market, let them. A credit union’s goal should be in providing members a fair deal while protecting the institution.

If your credit union would like to learn more about the positive aspects of subprime lending join us for The Opportunity in Subprime Lending Is Right Now, a webinar brought to you by Callahan and Associates.




April 2, 2007


  • You raise good issue - just wonder how to regulatory environment will change regarding subprime?
  • For smaller CUs not able to lend, partnering with a reputable, independent mortgage firm will allow Members the opportunity to seek out sound advice and guidance in this turbulent market. With access to those sub-prime lenders still originating loans, these qualified brokers can provide great synergy with Members. As Mr. Howard notes, control of the process is important. Thus if structuring an arrangement with an outside vendor the CU needs to do its due diligence properly.
    Dana Korosi
  • Good practical advice in light of difficulties at New Century Financial Corp and other lenders. Since 68% percent of FICUs offer mortgage loans and those loans represent a relatively small 2% of the total mortgage market, CUs should not avoid this segment, rather ensure these loans are prudently underwritten and clearly understood by borrowers. CUs should also hold out during the early part of spring training to avoid calisthenics. -Frank Howard
    Frank Howard
  • Sub-prime lending when done with complete knowledge of the sub-prime market is and has always been very profitable. The NCUA has stated they feel sub-prime lending is good for credit unions, they just don''t feel it should be out sourced to a third party originator and the credit unions give up control.
    Frank Mercer
  • This is a no-brainer to me. Credit unions SHOULD be in this market. The regulatory environment in credit unions certainly means that there''s less of a chance for subprimes to self-destruct than they way they have with Wall Street footing the bill. Moreover, the people who need subprimes are the people credit unions are SUPPOSED to be serving anyway. Whether we acutally are is another question.
  • Great insight, love all of the comments.