Keep Lending Through a Downturn

The consensus seems to be that the U.S. economy is heading toward an economic downturn of indeterminant proportions. And rates won’t be doing credit unions any favors as the Fed has softened its stance on increasing rates – in fact, it has indicated a potential cut, pinching credit union margins. As a former credit union CEO, I believe now is the perfect time for credit unions to grow their market share.

Credit unions have experienced tremendous growth in many areas, but especially auto lending. Even as other types of lenders have slowed due to slower demand and record default rates, credit unions haven’t slowed nearly as much and are not experiencing the same trouble. Karim Habib of CUNA Mutual recently shared during the MDDCCUA Annual meeting that credit union auto loan balances are at record highs, experiencing 9.4% CAGR between 2012 and 2017. Credit unions have grown the most market share at 14.8%, with 20.1% of the growth coming through indirect loans and direct loans trailing behind in growth at 8.7%. He projected auto loans to account for 61% of credit union lending by 2021, up from 56% as of 2017.

Indirect lending is credited with much of that growth, which is great, but credit unions can have difficulty building deeper relationships with these members – a key aspect of credit union membership and profitability. Between 2015 and 2017, Habib said, credit unions grew auto loans by 22%, but consumers who consider their credit union their primary financial institution only increased 7%, meaning the non-PFI members of this segment grew 44%.

While Lending Club and the like are known for quick transactions, credit unions can compete by capitalizing on building relationships with their members. Providing service to those whom other lenders won’t is a powerful way to accomplish that.

The real opportunity for credit unions is in the near-prime market. For some, lending to anyone with a credit score of 650 or below is unthinkable, but alternative data can help mitigate that risk. I call this the profit zone, and there’s a real void to fill for these consumers.

Nearly all loan decisions are based on a FICO score, and that’s important, but that’s just one piece of data. Copious data exist to help credit unions feel more at ease in making a non-prime auto loan. We recognize that borrowers – human beings – are more than that snapshot in time, so consider adjusting to acknowledge LexisNexis scores, which include education records, phone records, utility bills and more, to obtain a more complete picture. One of the many discoveries we’ve made with this data at Open Lending is that how long someone has lived in their home is a good indicator of their ability to repay their car loan.

By harnessing the power of LexisNexis data, a 580 FICO score with a positive LexisNexis score can be considered more favorably than a 620 FICO borrower with a lower LexisNexis score, and your credit union can price accordingly.

We’ve also learned not to go too far out with loan terms, because the longer the term of the loan, the lower the collateral value. But then again, different vehicles depreciate at a variety of rates, so it is important information to have when considering the loan amount and terms. For example, a Chevrolet doesn’t hold its value as well as a Toyota, so a Toyota may earn a longer-term loan, which will lower the payments for a borrower more than another type of car would.

Loan-to-value is another data point lenders must consider. The chance of default increases when the borrower has less skin in the game. However, that statistic is not as predictive as the payment-to-income ratio. In my experience, borrowers generally default because of a difficult life event, like a job loss or divorce. Because borrowers need their cars to get to work and pay their bills, they don’t walk away from their car loans simply because they lack a certain amount of equity.

Geographic data is another critical piece to keep in mind. You’ll recall the so-called Sand States of the Great Recession, in which home values plummeted and defaults increased the fastest. Credit unions should be regularly evaluating regional data for economic, lending and default patterns.

Most importantly, credit unions know and understand their borrowers better than most other types of lenders. Credit unions are generally local, and the not-for-profit status allows them to operate countercyclically. While other lenders’ auto loan default rates are increasing dramatically, statistics from the NCUA show credit union loan delinquencies have been holding steady, even slightly down at 0.53% as of March 2019. And credit unions’ rates can’t be beat, particularly in the lower credit buckets, so I see great opportunity in auto loan refinancing on your horizon. Follow what all the data tell you about a borrower. Keep lending through the expected economic downturn, and the people you help will remember your credit union when we come out the other side, creating deeper relationships and choosing your credit union as their primary financial institution.

John Flynn is CEO of Open Lending. He can be reached at 512-892-0400 or jflynn@openlending.com.