How High-Risk Lending Reaps Rewards

Azalea City Credit Union ($25.1M, Mobile, AL) and Southern Chautauqua Federal Credit Union ($78.5M, Lakewood, NY) don’t share much geography, but they lend from the same playbook.

Both work extensively with the types of borrowers who often turn to pay-here lots or payday lenders; they both charge higher-than-market rates for loans; and they both end up with more bad loans than most credit unions their size.

“We have a high delinquency rate,” says Ola Anise, president and CEO of three-branch Azalea City in the historic Gulf Coast community. “It is what it is. So, do we accomplish our mission of people helping people, or do we only help people with a Beacon score of 640 or higher? If that’s the case, we might as well be a bank.”

Meanwhile, 1,100 miles up the road, John Felton, president and CEO of Southern Chautauqua FCU, oversees a six-branch operation that serves small towns and rural communities in what he calls the real upstate New York.

“A-paper auto loans can sustain the credit union,” he says. “But, C-D-E-paper borrowers need us the most.”

It turns out, these credit unions can serve riskier borrowers and still keep the lights on, which is an important balance for boards of directors.

We explain to our board what the numbers mean, Anise says. But we also show them how you can get so caught up in the ratios and numbers that you forget these are real people.

Felton adds: We’re helping 150% more people get the reliable transportation they absolutely must have.

So many credit unions are afraid of the what ifs’ that it stops them from recognizing their victories.

The loan rates of these two credit unions reflect the need to realistically consider risk while setting up program parameters.

Azalea City’s most common interest rate is 8.57% on used cars and 17.54% on unsecured lines of credit, according to data from Callahan Associates. For Southern Chautauqua, it’s 18.00% on used cars and 17.99% on credit lines. The national average of the most common interest rate for all 5,913 credit unions reporting to the NCUA last quarter was 4.84% and 10.94%, respectively.

The result is that Azalea City’s overall yield on loans is 8.08%, compared with 7.38% for Southern Chautauqua and 5.19% for the 1,573 credit unions with $25 million to $100 million in assets as of March 31, 2017.

That hasn’t scared off borrowers, though. Neither credit union participates in indirect lending, yet their loan growth has been much stronger than their asset-based peer group.

Azalea City’s auto lending growth peaked at 50.9% year-over-year in the fourth quarter of 2016 and was still up nearly 43% in first quarter 2017. Southern Chautauqua’s was up 26.3% last quarter. Auto loan growth in the past two years has increased significantly at the two cooperatives, whereas the peer group average remained flat at approximately 8.8%.

Both are also well loaned out, with loan-to-share ratios of 83.98% for Southern Chautauqua and 84.74% for Azalea City, compared with 59.87% for the asset-based peer group.

Risk-Based Lending

On the flip side, Azalea City’s delinquency rate on loans is 3.35% as of March 31, 2017, compared with 1.96% for Southern Chautauqua and the 0.95% average for similarly sized credit unions.

Net charge-offs also are much higher than peer averages: 1.50% for Southern Chautauqua and 1.40% for Azalea City, compared with the 0.47% average for credit unions with $25 million to $100 million in assets.

These numbers reflect Southern Chautauqua’s and Azalea City’s approach to risk-based lending and collecting alike.

“You have to look at the psychology behind the score”, Anise says.

Do we accomplish our mission of people helping people, or do we only help people with a Beacon score of 640 or higher? If that’s the case, we might as well be a bank.

Reasons vary for why a borrower has a credit score of 550 or 575. It could be from not knowing how to manage money or credit even if they have a healthy income and the willingness to learn. Or, there might be other reasons the credit union deems the borrower an acceptable risk. For example, they might have a relationship with the credit union that goes back for years and extends through the family.

“That relationship is often why they come to us,” Anise says. “It’s up to us to separate who is gaming the system from who is having hard times. That’s the psychological aspect.”

And members apparently appreciate the chance to demonstrate they are a good risk. The little Alabama credit union scores 94.60 out of 100 in Callahan’s proprietary Return Of The Member measure of member engagement.

“They’re rewarding us with their business,” Anise says.

Risk-Based Collecting

Both credit unions stress being proactive when payments fall behind. Anise says, depending on the borrower, his lenders make calls when a payment is as few as 10 days late and follow-up in as soon as three days.

“We’re risk-based collectors,” he says. “A lot of times, these folks have more than one collector calling them. You have to engage them. That’s also part of the psychological aspect of lending. If we’re taking the risk to lend to them, we want them to feel like their credit union should be at the top of the list for paying back.”

Up in western New York, Southern Chautauqua also keeps a short lease on potential problem loans. According to Felton, the credit union starts stressing it is helping borrowers in ways no other lender would during the application process. It also stresses the benefits borrowers gain from keeping their end of the deal.

For example, missed payments warrant phone calls and this explanation: We’re not going to allow this to continue because it keeps your credit score low and hurts you, Felton says.

“These are difficult conversations,” the CEO says. “But they must happen. The best way to help people get on their feet, and stay there, is to not allow delinquencies more than 60 days. After that, we repossess the car.”

That is, unless the borrower makes arrangements to repay and then follows through.

Before many of its riskier borrowers take possession of a car, Southern Chautauqua equips it with GPS devices that can disable the vehicle. The credit union maintains its own online auction site for repos, and according to Felton, the credit union has sold approximately half of the 200 vehicles it has taken back this year.

That’s not the only resolution for delinquent accounts, however. Before sending a car to action, the credit union gives borrowers a 10-day window to favorably resolve the repossession. Only then does Southern Chautauqua sell the vehicle.

The credit union makes approximately 175 car loans a month, according to Felton, and of those, about 30% are C-D-E paper. That does carry risk. But it also carries reward.

“So many credit unions are afraid of the what ifs’ that it stops them from recognizing their victories,” Felton says. “What if 650 people now have transportation so they can keep their jobs? So, I take back 65 cars. Look at what we helped a lot of people achieve.”