Driven to Serve
Nonprime auto loans can boost members’ economic mobility and fuel CU yields.
The lack of a vehicle is one of the top barriers to escaping poverty, according to the Annie E. Casey Foundation. That’s a key reason why, at $78 million asset Greenville (S.C.) Heritage Federal Credit Union, nonprime auto lending isn’t merely a sideline, it’s a mission.
“It allows us to serve the folks banks have shut the door on completely,” says Alan Berry, CEO of the NCUA-designated low-income credit union.
Nonprime, or subprime, lending is the practice of making loans to borrowers with blemished or nonexistent credit histories, or those with limited payment capacity. Properly managed, nonprime loans give credit unions the means to help members who have limited options while increasing loan portfolios and yields.
Nonprime loans—C, D, and E paper—make up 40% of Greenville Heritage Federal’s entire loan portfolio, not just auto loans. The credit union’s nonprime auto loan rates start at around 12%.
Members with credit scores below 550 pay 17.99%—far less than the 28% or more they’d pay elsewhere in town.
The credit union has no minimum required credit score for auto loans, although “that doesn’t mean we lend to every 450 [score] that comes through the door,” he says. “But we don’t automatically turn anybody away.”
Last year, charge-off s stood at 1.49% while delinquencies usually range from 0.75% to 1% for the entire loan portfolio, of which auto loans comprise 60%.
“But our loan yield is still at more than 8%,” Berry says. “The key is to keep the rates high enough so you can stomach the charge-off s.”
Constant monitoring and centralized underwriting are critical success factors, he adds (“Seven steps to subprime success,” p. 29). When the delinquencies and charge-off s begin to nudge uncomfortably high, “we pull the needle back,” he says. “You have to constantly adjust your risk tolerance.”
NEXT: Preventing ripoffs
When Dave Prosser looks back at four years of offering nonprime auto loans at Freedom First Federal Credit Union in Roanoke, Va., one member stands out: the credit union’s first nonprime auto loan recipient.
The borrower was a single woman who was raising a young nephew on her own and had to rely on public transportation to get around, explains Prosser, senior vice president of community development at the $331 million asset credit union. That meant she could only work at jobs accessible by bus, even though many better-paying workplaces weren’t on a bus line.
Grocery shopping by bus was a struggle because she had to manage as many bags as she could carry with a five-year-old in tow. So she frequently resorted to buying food at exorbitant prices at a convenience store close to home, straining her limited budget.
Getting a loan to buy a car made her life easier, and by paying back the loan she began to build a solid credit history.
It’s a result Prosser has seen time and again among nonprime auto loan borrowers at his credit union. “We’ve had some people improve their credit ratings and go on to become homeowners,” he says.
Freedom First Federal is one of 14 credit unions participating in an 18-month pilot project launched in April 2014 by the National Credit Union Foundation (NCUF) in partnership with the Filene Research Institute.
Half of the participating credit unions have experience with nonprime auto lending, while the rest are new to it. Pilot participants will learn from each other while also demonstrating to other credit unions that nonprime auto lending can be a winning proposition for everyone involved.
Participants set their own definition of “nonprime,” such as credit scores below 640 or 620. Different credit unions also use different credit scoring systems.
For members, the big benefits are lower monthly payments and enormous interest savings. Without a credit union loan, nonprime borrowers would have to turn to high-cost predatory lenders or “buy here, pay here” car lots where auto dealers provide financing—typically at exorbitant interest rates.
“We know that the best nonprime rate you’ll find outside a credit union is about 18% today. At the worst, the rate can be in the high 20s or low 30s,” says Mark Lynch, field coach for NCUF’s Real Solutions program, which includes the nonprime lending pilot project. He notes that credit unions’ nonprime auto loan rates generally are in the 10% to 18% range depending on the local market.
Not only do nonprime vehicle loans benefit members, credit unions also stand to gain.
Among the pilot participants with experience with these loans, “in every single instance, they have found that despite higher administrative costs and higher delinquencies, these loans are substantially more profitable than other loans in their portfolio,” says Lois Kitsch, NCUF national program manager.
Nonprime auto lending is also a way to put the credit union mission into action, Kitsch says, by providing affordable financial services to those who need them most. “Credit unions that turn away from this type of lending are missing a tremendous opportunity to practice our philosophy.”
NEXT: Mutual commitment
Freedom First Federal offers nonprime auto loans through its “Responsible Rides” program (CU Mag 11/13, p. 40). Participants get much more than a loan. They enroll in a financial education course, get help in setting up a savings plan, and take an auto maintenance class.
Plus, the loan program manager goes car shopping with the members. “It’s work for borrowers to go through our process,” Prosser says. “People who say this is too hard are the ones we can’t help. We look for a level of commitment.”
In turn, the credit union commits to helping these borrowers achieve self-sufficiency. “This program is hightouch,” Prosser explains. “We invest time and resources in these people so we think they’re more likely to pay us. They feel they’ll let us down if they don’t make a payment.”
That approach is working. Both the delinquency and charge-off rates for these loans are below 0.50%.
Nonprime loans make up about 10% of the credit union’s total auto loan portfolio.
The credit union sets no minimum credit score for loan eligibility. Last year it granted 44 loans to borrowers who had no credit score.
The typical borrower is a single mother with an annual household income of $18,000. Borrowers are referred by one of the local nonprofits that partners with Freedom First Federal, an NCUA-designated low-income credit union.
All borrowers pay 9.99% in interest, and the average loan amount is $11,500. The credit union makes a “marginal profit” on these loans, Prosser says.
What’s more, he adds, “we hope to expand on the relationship with these members, and we’re also strengthening our relationship with our nonprofit partners in the community.”
NEXT: 'Story' loans
CU Direct Corp.:
CU Lending Advice:
1. Environmental Scan resources: cuna.org/strategicplanning
2. CUNA Lending Council Conference, Nov. 2-5 in San Diego: cunalendingcouncil.org
Filene Research Institute:
National Credit Union Foundation’s Nonprime Auto Loan Toolkit:
While Freedom First Federal offers nonprime auto loans through its Responsible Rides program, Sun Federal Credit Union in Maumee, Ohio, does risk-based pricing for all of its auto loans.
That allows the credit union to include nonprime loans in the mix, says Kay Burrell, director of lending for the $446 million asset credit union.
In making loan decisions, “we listen to the member’s story first,” Burrell says. “Then we balance that with our lending guidelines to find something the member is able to pay.”
Once the decision is made to grant the loan, Sun Federal looks at the credit score to set the price. On loans with 37- to 72-month terms, for instance, members with credit scores of 740 or higher pay 3.25%.
Credit scores under 640 are considered to be nonprime. Members with scores of 600 to 639 pay 8.75%, while those below 600 pay 11.25%.
“We spread our risk across all tiers,” Burrell says, “so we get a good return on the entire portfolio.”
Sun Federal has a $34 million auto loan portfolio of which nonprime loans account for 12%. The average loan amount is $13,700.
The 60-day delinquency rate for the entire auto loan portfolio, nonprime included, is 0.40%.
Burrell concedes it would be far easier to focus solely on borrowers with credit scores above a certain level instead of listening to each member’s story and evaluating each individual’s repayment ability.
“But that’s not who we are,” she says. “When people need help, we want to help them. It’s really about building a relationship with members for the rest of their lives.”