Enhancing Credit Union Income

 

 

 

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Most credit unions have great performing portfolios of prime loans, but these prime portfolios are built with borrowers that can obtain loans anywhere.  Credit Unions need to establish a "risk tolerance" policy that allows them to serve some of the under served customers in their membership area.  An under served customer is described as a person exhibiting higher delinquency or default risk characteristics than those of traditional prime borrowers.  These are good people that are attempting to repair their credit history because of previous credit problems, and those attempting to establish or expand their credit history.  This type of lending is most commonly referred to as sub-prime lending.

 

During 2005, the NCUA responded to the rapid growth in sub-prime lending with a series of examinations designed to evaluate the planning, loan production, loan servicing, and risk management practices employed by many credit unions engaged with third party originators.  These examinations uncovered a number of serious weaknesses in the business and control processes used to manage the risks associated with sub-prime lending activities. 

 

The deficiencies were more profound in two types of credit unions:  those that knowingly engaged in sub-prime lending without an adequate understanding of the risks involved and those that unwittingly entered the market by relaxing underwriting standards or loosening credit-grading criteria in response to competition.

 

While many of the principles and operational requirements are similar to traditional prime consumer lending, the need for increased attention to detail is heightened with the increased level of risk assumed with sub-prime lending.  Consequently, credit unions should engage in sub-prime lending with a clear understanding of the business and its inherent risks and a well conceived business plan clearly defining the credit unions risk tolerance policy.   Credit Unions should develop and implement comprehensive policies and procedures specific to each sub-prime product before initiating activity.  The policies should provide well-defined guidance pertaining to risk tolerance, terms, operating procedures and collection activities. It is critical that underwriting policies and procedures incorporate the risk tolerances established by the board and management and explicitly define underwriting criteria and exception processes.  Collection processes are generally more intensive than in prime lending operations.  Credit unions should have well-defined written collection policies and procedures that include issues such as default management (cure programs and repossessions), re-marketing efforts, and strategies to minimize delinquencies.  Steps need to be taken to ensure that exposures from operational deficiencies, collateral imperfections are minimized. Effective and comprehensive control functions help avoid the assumption of unanticipated risk. 

 

Sub-prime lending can be a viable means of enhancing credit union income and meeting the credit needs of underserved and unserved markets.  However, it requires specialized expertise, sound planning, and comprehensive analysis and systems to control the elevated risks associated with these activities.  The absence of such safeguards in a credit union that is materially engaged in sub-prime lending may constitute an unsafe and unsound practice.

 

 
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