Grow Your Loan Portfolio. Randy C. Thompson, Ph.D. CEO TCT Risk Solutions LLC (A CUSO)

Grow Your Loan Portfolio Randy C. Thompson, Ph.D. CEO TCT Risk Solutions LLC (A CUSO)

Over the past six years, credit unions have reduced rates on loans dramatically while they all compete for a diminishing share of A+ and A grade loans. Survey of 75 credit unions 2010 average A+ loan rate was 4.62% 2016 average A+ loan rate is 1.78% Drop of 2.84%

Tiered Pricing Income Effects Credit Union 2011 Yield 2012 Yield Change Loan Balance Interest Income Lost 1 5.57% 4.71% -0.86% 129,714,000 (1,115,540.40) 2 7.28% 6.46% -0.82% 26,910,000 (220,662.00) 3 7.54% 6.58% -0.96% 10,888,000 (104,524.80) 4 7.43% 5.81% -1.62% 79,484,000 (1,287,640.80) 5 6.45% 5.64% -0.81% 18,933,000 (153,357.30) 6 8.16% 7.29% -0.87% 199,438,374 (153,357.30) 7 5.76% 4.87% -0.89% 182,550,000 (1,624,695.00) 8 6.29% 5.48% -0.81% 136,821,000 (1,108,250.10) 9 6.28% 5.91% -0.37% 18,448,000 (68,257.60)

Does This Really Make Sense? Doing the same thing over and over and expecting different results? We need a new approach to increase income, build equity to Sustain our Credit Unions

Six Elements to Improve Yields and Sustain Viability. Understand Risk Impacts Create a Risk-Friendly Environment Employ Risk Management Tools Implement Risk Responsive Decisioning Fund Risk through Cost Responsive Risk Base Pricing Manage Changing Risk Over Time

Impact of Risk Grade A C Balance 1,000,000 1,000,000 Rate 2.99% 12.99% Earnings 29,900 129,900

Impact of Risk Grade A C Loss Rate 0.50% 4.00% Losses 5,000.00 40,000.00

Net Gain of Risk Acceptance Grade A C Balance 1,000,000 1,000,000 Rate 2.99% 12.99% Earnings 29,900 129,900 Loss Rate 0.50% 4.00% Losses 5,000.00 40,000.00 Net Income 24,900.00 89,900.00 Improvement 65,000.00

NCUA Guidance on Risk NCUA Guidance Letter - 174 Risk-based lending allows credit union management to assess the risks involved in different types of loan products and price these products based upon the inherent risk associated with individual borrowers. The end result is a more diversified loan portfolio mixing lower-yielding, lower risk loans with higher-yielding, but riskier loans. Prior to beginning a risk-based lending program, it is important that the credit union board determine the parameters for the riskier loans based on the credit union's financial condition, business plan, lending and collection history, and asset liability management (ALM) program. August 1995

NCUA Guidance on Risk NCUA Guidance - Letter 174 Credit unions should engage in risk-based lending, not as a means of re-pricing existing balance sheets, but as a tool to reach out to the under-served and take a risk that might otherwise be avoided. Risk-based lending involves setting a tiered pricing structure that assigns loan rates based upon an individual's credit risk. Through a carefully planned risk-based lending program, credit unions may be able to make loans to somewhat higher-risk borrowers, as well as better serve their more credit-worthy members. August 1995

Create Risk Responsive Policies Policies that work Clarify acceptable loans Specify the percent for each grade Specify terms for each grade Specify maximum loan amounts for each grade Specify minimum rate spreads for each grade

Application in a Credit Union Tools to control risk Tools and techniques that mitigate risk of collateral loss Allows greater flexibility in lending decisions Provides behavior modification to increase timely payments Tracks collateral to marginalize loss of collateral

Effective Risk Mitigation Techniques and Tools Collateral Tracking Systems Indicator light showing payment is due Starter interrupt to prevent usage if delinquent GPS locator to aid collection and repossession Short-Term Financing Minimum exposure Requires automated payment Transformational Interest Rate Reinforces timely payments Promotes long-term members

Early Decisioning Model Profile Criteria Employment 1 Year Max D/I 45 Unsecured D/I 35 Delinquency 30+ current Del. On Home or Car None 60+ current Del. In past 24 mths/none Max Times Del. In Pst Year None Open Coll. Accts in 24 mths Rate Bump Products Secured Loans Min/Max Amt 2,500.00-100,000.00 Max Mileage 120,000 Max Term 96 LTV 120 / 150 Gap Signature Loans Min/Max Amt A=500.00-15,000.00 A+=500.00-25,000.00

Embracing Risk Purpose of risk based lending Diversify loan portfolio Extend loans to underserved Make loans we would otherwise avoid

Embracing Risk Need to expand the way we underwrite Expand criteria Create multiple descriptions of acceptable borrowers Match loan offerings with description

Expanded Decisioning Model Profile Criteria Profile A (A & A+) Employment 1 Year Max D/I 45 Unsecured D/I 35 Delinquency 30+ current Del. On Home or Car None 60+ current Del. In past 24 mths/none Max Times Del. In Pst Year None Open Coll. Accts in 24 mths Rate Bump Products Secured Loans Min/Max Amt 2,500.00-100,000.00 Max Mileage 120,000 Max Term 96 LTV 120 / 150 Gap Signature Loans Min/Max Amt A=500.00-15,000.00 A+=500.00-25,000.00

Expanded Decisioning Model Profile Criteria Profile A (A & A+) Profile B (B & C) Employment 1 Year 6 Months Max D/I 45 45 Unsecured D/I 35 25 Delinquency 30+ current Del. On Home or Car None None 60+ current Del. In past 24 mths/none 12 mths/none Max Times Del. In Pst Year None 3 or 4 Open Coll. Accts in 24 mths Rate Bump Rate Bump Products Secured Loans Min/Max Amt 2,500.00-100,000.00 2,500.00-50,000.00 Max Mileage 120,000 100,000 Max Term 96 72 Month LTV 120 / 150 Gap 100 Signature Loans Min/Max Amt A=500.00-15,000.00 C=500.00-5,000.00 A+=500.00-25,000.00 B=500.00-7,500.00

Expanded Decisioning Model Profile Criteria Profile A (A & A+) Profile B (B & C) Profile C (D & E) Employment 1 Year 6 Months 60 Days Max D/I 45 45 45 Unsecured D/I 35 25 20 Delinquency 30+ current Del. On Home or Car None None None 60+ current Del. In past 24 mths/none 12 mths/none 6 mths/none Max Times Del. In Pst Year None 3 or 4 6 Open Coll. Accts in 24 mths Rate Bump Rate Bump Rate Bump Products Secured Loans 2,500.00-50,000.00 2,500.00-20,000.00 Min/Max Amt 2,500.00-100,000.00 Max Mileage 120,000 100,000 100,000 Max Term 96 72 Month 60 Months LTV 120 / 150 Gap 100 90 Signature Loans Min/Max Amt A=500.00-15,000.00 C=500.00-5,000.00 E=500.00-1,000.00 A+=500.00 -

Adjusting Rate for Risk Criteria Bump Rate Base Rate Employment 0.25% Max D/I 0.50% Unsecured D/I 0.50% Delinquency 0.50% Max Amt 0.25% Max Mileage 0.25% Max Term per Year 0.25% LTV 0.25% Misc 0.50% Under E Range: 549-500 1% Total Rate

NCUA Guidance Letter - 174 The key to successful risk-based lending is to ensure that prices (rates) correctly reflect the risk and costs involved. August 1995

Risk Based Pricing We define risk, in relation to the loan portfolio, as the likelihood that money that has been expended or extended by the credit union will not return. Money expended includes cost of funds, loan operations and collections. Money extended includes charge-offs of principle balances. These items are identified as costs and as such can be statistically (stochastically) quantified and measured. The consistent and complete measurement of these costs is foundational to an accurate and effective loan pricing system.

Counting Up the Costs Terms A+ A B C D E 740+ 720-739 680-719 630-679 600-629 <600 Cost of Funds 0.21% 0.21% 0.21% 0.21% 0.21% 0.21% Booking 0.43% 0.46% 0.47% 0.49% 0.63% 0.72% Collections 0.05% 0.10% 0.17% 0.22% 0.30% 0.37% Charge-offs 0.28% 0.31% 0.40% 0.65% 2.26% 3.56% Totals Cost 0.97% 1.08% 1.25% 1.57% 3.40% 4.87% Fixed Margin 2.00% 2.00% 2.00% 3.00% 4.00% 5.00% Anchor Rate 2.97% 3.08% 3.25% 4.57% 7.40% 9.87

Adding Up the Benefits A+ A B C D E Loan Balance 837,000.00 333,000.00 298,200.00 124,800.00 189,600.00 217,400.00 Percent of Total 41.85% 16.65% 14.91% 6.24% 9.48% 10.87% Gross Revenues 26,421.30 12,454.20 14,880.18 9,472.32 21,311.04 32,588.26 Costs Cost of Funds 1,768.10 703.44 629.93 263.63 400.52 459.24 Booking 3,620.05 1,515.59 1,392.37 606.19 1,189.25 1,564.56 Collections 396.02 339.35 513.71 275.56 563.54 812.33 Charge-offs 2,334.73 1,038.76 1,204.55 817.37 4,288.64 7,745.83 Total Cost 8,118.90 3,597.14 3,740.56 1,962.74 6,441.95 10,581.97 Net Revenues 18,302.40 8,857.06 11,139.62 7,509.58 14,869.09 22,006.29

Vital Statistic Credit Migration 60% to 80% of all losses come from loans that were made in higher grades and then experienced a falling FICO score.

Credit Migration Many names for the same concept Credit migration Multi-dimensional portfolio management On-going decisioning Migration Analysis

Credit Migration No matter what name you use it is an important tool for managing the risk in your loan portfolio; Loan losses are directly tied to it; Examiners are asking for, and in cases, requiring it; and FASB is currently examining changing guidance to focus on credit migration in allowance calculation

Credit Migration Understanding your Loan Portfolio Credit risk can Increase or Decrease Which risk pools are improving impairing? Identifying Potential Problems Isolate impaired loans and react to them early Understand the risk in your pools and adjust lending practices Identifying Emerging Opportunities Recognize Members that are making smart decisions Proactively offer ways to help your members Understand which pools of loans to take on more risk Applying Precision in Allowance Calculation Statistically based calculation Complying to regulations

Understand Your Credit Portfolio Create migration matrix for total portfolio Original FICO and Current FICO

Understand Your Credit Portfolio Individual Pools within the Portfolio Auto Dollar Original FICO Grades Current FICO A+ A B C D E Not Reported Grand Total A+ 740+ 4,228,813 909,321 333,652 85,855 20,612 8,407-5,586,660 A 690-739 785,739 2,500,183 607,437 288,288 49,362 41,129-4,272,137 B 660-689 139,806 583,078 1,535,533 472,715 131,580 66,828-2,929,541 C 630-659 97,711 387,926 611,213 960,404 236,555 223,545-2,517,354 D 600-629 68,588 288,702 241,361 368,703 656,849 298,887 8,499 1,931,588 E <600 94,175 269,109 261,993 698,948 704,398 1,524,336-3,552,959 Not Reported 161,483 88,712 84,057 118,704 23,768 17,211 15,526 509,460 Grand Total 5,576,315 5,027,031 3,675,245 2,993,617 1,823,124 2,180,342 24,025 21,299,699 Loans Not Risk Rated and Adjustments 33,765 Total in Portfolio 21,333,464 Percent Original FICO Grades Current FICO A+ A B C D E Not Reported Grand Total A+ 740+ 75.84% 18.09% 9.08% 2.87% 1.13% 0.39% 0.00% 26.23% A 690-739 14.09% 49.73% 16.53% 9.63% 2.71% 1.89% 0.00% 20.06% B 660-689 2.51% 11.60% 41.78% 15.79% 7.22% 3.07% 0.00% 13.75% C 630-659 1.75% 7.72% 16.63% 32.08% 12.98% 10.25% 0.00% 11.82% D 600-629 1.23% 5.74% 6.57% 12.32% 36.03% 13.71% 35.38% 9.07% E <600 1.69% 5.35% 7.13% 23.35% 38.64% 69.91% 0.00% 16.68% Not Reported 2.90% 1.76% 2.29% 3.97% 1.30% 0.79% 64.62% 2.39% Grand Total 100% 100% 100% 100% 100% 100% 100% 100%

Understand Your Credit Portfolio Net Risk Change 4,000,000 3,500,000 3,000,000 2,500,000 2,000,000 1,500,000 1,000,000 500,000 Risk Change by Grade - A+ A B C D E Total Impaired Improved

Understand Your Credit Portfolio Delinquency by Change Group Delinquency by Credit Grade Migration 0.00% 3.30% 27.43% 69.28% Improved Impaired Unchanged Not Reported

Understand Your Credit Portfolio Charge-offs by Change Group Charge off by Credit Grade Migration 90.00% 80.00% 77.03% 70.00% 60.00% 50.00% 40.00% 30.00% 20.00% 10.00% 0.00% 18.44% 4.53% 0.00% Improved Impaired Unchanged Not Reported Improved Impaired Unchanged Not Reported

Identify Potential Problems in the Dollar Portfolio Drop of 2 or more credit grades is an impaired FICO 60%-80% of Delinquencies and Charge-offs come from impaired FICO score loans By responding early you can minimize losses Original FICO Grades Current FICO A+ A B C D E Not Reported A+ 740+ 33,886,855 4,911,282 1,696,945 425,522 105,543 63,014 3,184,419 A 690-739 7,886,015 11,359,190 5,212,544 857,840 146,917 147,464 1,828,060 B 660-689 1,857,191 4,601,064 10,527,101 2,055,535 1,333,417 158,714 537,630 C 630-659 910,286 910,852 2,541,847 2,547,064 886,367 848,199 268,658 D 600-629 17,970 123,766 1,503,642 2,480,152 715,706 525,812 526,391 E <600 91,237 610,842 1,026,951 2,088,359 717,708 643,272 563,043 Not Reported 75,089 29,047 481,778 189,437-300 472,982 Grand Total 44,724,643 22,546,043 22,990,809 10,643,908 3,905,658 2,386,776 7,381,182 Grand Total 44,273,580 27,438,030 21,070,652 8,913,273 5,893,438 5,741,413 1,248,632 114,579,017

Identifying Impaired Loans Visa MEMNUM SUFFIX Loan Code Pool BALANCE ORGFICO Orig. Grade Current FICO Curr. Grade OPENDATE Credit Limit Additional at Risk Total At Risk 91218 700 VC Visa 450.00 751 A+ 689 B 11/28/2011-450.00 90673 700 VC Visa 465.40 749 A+ 672 B 1/12/2011-465.40 89902 700 VC Visa 1,347.40 741 A+ 661 B 11/3/2011-1,347.40 81682 700 VC Visa - 785 A+ 682 B 11/3/2008 - - 79710 700 VC Visa - 759 A+ 686 B 10/25/2006 - - 73017 700 VC Visa 4,527.32 746 A+ 688 B 7/21/2008-4,527.32 65431 701 VC Visa 3,173.60 742 A+ 680 B 1/19/2010-3,173.60 63405 700 VC Visa 3,453.40 754 A+ 665 B 7/16/2004-3,453.40 52319 700 VC Visa 12,848.16 751 A+ 665 B 5/31/2002-12,848.16 50107 700 VC Visa 1,889.54 778 A+ 688 B 9/3/2003-1,889.54 49936 700 VC Visa 1,514.19 768 A+ 683 B 11/13/2003-1,514.19 37893 700 VC Visa 6,304.62 741 A+ 681 B 2/6/2009-6,304.62 23051 700 VC Visa 2,164.17 745 A+ 668 B 12/26/2007-2,164.17 15230 700 VC Visa 7,058.49 792 A+ 679 B 11/27/2001-7,058.49 66739 700 VC Visa 931.65 776 A+ 653 C 10/9/2009-931.65 65704 700 VC Visa 9,943.70 752 A+ 659 C 11/22/2004-9,943.70 63370 700 VC Visa 484.04 748 A+ 650 C 7/19/2011-484.04 57717 700 VC Visa 5,164.89 768 A+ 630 C 12/5/2001-5,164.89 44936 700 VC Visa - 775 A+ 657 C 7/24/2003 - - 43776 700 VC Visa 1,903.78 753 A+ 647 C 6/18/2004-1,903.78 42425 700 VC Visa 7,078.64 748 A+ 636 C 10/9/2007-7,078.64 40280 700 VC Visa 6,166.54 765 A+ 640 C 4/9/2002-6,166.54 92159 700 VC Visa 1,934.57 712 A 645 C 1/18/2012-1,934.57

Identifying Impaired Loans Loan Type Balance Original FICO Current FICO Open Date Rate Limit Unsecured 500 759 A+ 617 D 2/8/2013 14.99% 5,000

Bankruptcy Narrative Quality cash flow and lifestyle Trauma to cash flow Switch from cash flow to unsecured debt Max out the unsecured debt Declare Bankruptcy Act early and minimize exposure

Identifying Emerging Opportunities Improving Credit scores are also important Central mission of helping members Targeted marketing Increased loyalty Upsell opportunities Dollar Original FICO Grades Current FICO A+ A B C D E Not Reported A+ 740+ 33,886,855 4,911,282 1,696,945 425,522 105,543 63,014 3,184,419 A 690-739 7,886,015 11,359,190 5,212,544 857,840 146,917 147,464 1,828,060 B 660-689 1,857,191 4,601,064 10,527,101 2,055,535 1,333,417 158,714 537,630 C 630-659 910,286 910,852 2,541,847 2,547,064 886,367 848,199 268,658 D 600-629 17,970 123,766 1,503,642 2,480,152 715,706 525,812 526,391 E <600 91,237 610,842 1,026,951 2,088,359 717,708 643,272 563,043 Not Reported 75,089 29,047 481,778 189,437-300 472,982 Grand Total 44,273,580 27,438,030 21,070,652 8,913,273 5,893,438 5,741,413 1,248,632 Grand Total 44,724,643 22,546,043 22,990,809 10,643,908 3,905,658 2,386,776 7,381,182 114,579,017

Identifying Improved Loans

Identifying Improved Loans Loan Type Balance Original FICO Current FICO Open Date Rate New Auto 18,432 645 C 787 A+ 4/18/2012 6.50%

Summary Regulations are Conducive Tools are Available Benefits will Strengthen your CU

Contact Randy C. Thompson, Ph.D. Phone: 208-939-8366 Email: rthompson@tctrisk.com Web: tctrisk.com