Private loan underwriting……...Understanding how lenders weigh the risks

Ben BrudnockVice President Education FinanceCitizens Bank

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Session topics

• Types of Consumer Loans• Impact of recession on credit underwriting• Underwriting basics• Factors that determine loan approval• Counseling advice• Private student loan evolution• Q&A

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Types of Consumer Loans

• Mortgages• Home Equity, Home Equity Line of Credit (HELOC)• Auto – RV – Marine – Motorcycle• Student Loan (federal or private)• Payday loans• Credit Cards• Personal loans against assets

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Impact of the recession on credit underwriting

• Root cause of the recession: Mortgage defaults• 5.4 million of 45 million (12.07%) mortgages nationwide were

delinquent or in some stage of foreclosure during QI 2009• Nearly 3 million homes foreclosed on during all of 2009 (1 in

45 homes); more than 2x number in 2007• Mixed signs of recovery:

• Only 2.2% of current mortgage balances transitioned into delinquency during 2Q 2011

• Total household delinquency rates have dropped for six straight quarters; now 9.9%

• However, mortgage originations over last four quarters were 44% lower than 2003-2007 averages

• Approx. $1.1 trillion of consumer debt is currently delinquent

Source: Federal Reserve Bank of New YorkSource: Federal Reserve Bank of New York

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• Faced with mounting losses, lenders (except Direct Loan PLUS) tighten standards on new loan applications

• How? • Higher minimum qualification standards (i.e. credit

score, income, co-signer requirements, etc.)• Longer historical look into personal finances• Increased pricing (fees and margins) • Exit the marketplace altogether

Impact of the recession on credit underwriting

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Impact of the recession on credit underwriting

Eased 31% 26% 6% 0% 2% 20%

Unchanged 63% 58% 42% 14% 33% 48%

Tightened 6% 16% 52% 86% 65% 32%

Credit Underwriting Practices: Commercial Products

2006 2007 2008 2009 2010 2011

Office of the Comptroller of the Currency (OCC), a division of the U.S. Treasury Department, publishes an annual survey of Credit Underwriting Practices. Those surveyed included 54 of the largest banks in the country with assets of $3 billion or more. 17 th Annual Survey results include:

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Impact of the recession on credit underwriting

Credit Underwriting Practices: Residential Construction

2006 2007 2008 2009 2010 2011

Eased 25% 17% 2% 0% 0% 0%

Unchanged 64% 50% 36% 8% 36% 63%

Tightened 11% 33% 62% 92% 64% 37%

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Impact of the recession on credit underwriting

Credit Underwriting Practices: Overall retail products

2006 2007 2008 2009 2010 2011

Eased 28% 20% 0% 0% 0% 7%

Unchanged 65% 67% 32% 17% 26% 63%

Tightened 7% 13% 68% 83% 74% 30%

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Underwriting basics

Definition: Loan underwriting is the process a

lender uses to determine whether the risk of lending to

a particular borrower under a particular set of circumstances is

acceptable.

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Underwriting basics

• Automated underwriting functions• Credit Scores• Credit History• Credit Utilization Ratio

• Manual (or semi-manual) underwriting functions• Minimum income requirements• Employment history• Debt to Income ratio (DTI)• Loan to Value ratio (LTV)• Down payment• Collateral / Appraisal

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FICO or Credit Scores Fair, Isaac and Company Developed the algorithm used by most credit bureaus to

calculate a credit score• A FICO score is the most commonly used credit rating• Credit scoring is a quick, objective & consistent method for

lenders to measure the “risk” of an applicant Scores based solely on information in consumer credit reports

maintained at the credit reporting agencies (Experian, TransUnion & Equifax)

• The higher the score, the lower the risk

Loan approval factors: Credit Scores

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Payment history35%

Amounts owed30%

Length of Credit History15%

Types of Credit in

Use10%

New Credit10% These percentages are

based on the importance of the five categories for the general population.

For particular groups – for example, those who have not been using credit for long – the importance of these categories may vary.

Source: www.MyFICO.comSource: www.MyFICO.com

Loan approval factors: Credit Scores

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Is there an average credit score?

According to Experian, the current national average

credit score is….

694Region Average CreditEast North Central 698

East South Central 683

Middle Atlantic 702

Mountain 688

New England 712

Pacific 694

South Atlantic 685

West North Central 709

West South Central 673

Notes: The average credit score in PA is 705

Highest state avg: 721 Lowest state avg: 670

Can you guess the states?

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Loan approval factors: Credit history

Lenders may screen for both the length and usage of credit

• Trade lines (individual credit accounts: balances, account status, date opened, credit limit, etc.)

• Credit inquiries (a list of everyone who has accessed your credit report during the past two years, both voluntary and involuntary.

• Public record and collection items (public record data from collection agencies and courts; info includes liens, judgments, bankruptcies and wage garnishments)

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Loan approval factors

• Debt to income (DTI) ratio• How a DTI is determined: Monthly household

liabilities divided by monthly household gross income = DTI (Also known as back-end/before mortgage DTI)

• Example: $3500 monthly bills / $10,000 gross monthly income = 35% DTI

What’s good?

What’s so-so?

What’s not so good?

DTI less than 28%

DTI between 28-36%

DTI greater than 36%

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Loan approval factors, cont.

• Income requirements• Verification of stated income• Minimum income requirements

• Employment history• Length of time with current employer• Document history of full-time employment (references)

• Credit Utilization ratio• Percentage of available credit currently in use• Difficult to determine the right mix

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Loan approval factors, cont.

• Down payment• Good sign of applicants ability to save• 20% of mortgage loan value can avoid PMI insurance

• Property – asset appraisal• Loan to Value (LTV): loan amount / purchase-appraisal price• Interest rates on Home Equity loans are often tied to LTV

percentages

• Co-borrowing• Mandatory for approval when applicants have little to no credit

history and/or income• Can often lead to better rates-fees compared to loans with one

creditworthy applicant

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A recipe for loan approval success

• Solid credit history• No instances of adverse credit / collections for 7 years• Little to no “minor” adverse credit instances

• Above average credit score• Best rates & fees for those with 725 or higher FICO

• Verifiable income & low DTI• Current & prior year W2’s and DTI less than 30%

• Borrow jointly• Two creditworthy co-borrowers and better than one

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The evolution of underwriting private student loans

That was then……………Approvals often based solely on FICO

Direct to consumer loans widely available to students without a co-borrower

Best interest rates were lower than Prime

Private loans made widely available to schools below bachelor’s degree level

Originating lenders could easily securitize loans for additional funds

2007 AD

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The evolution of underwriting private student loans

And this is now………….FICO is vital, but only part of equation

Direct to consumer loans are all but gone

While interest rates are low, margins are much higher

Associate level & below schools have limited private loan availability

Securitization market is weak for student loans; lenders still in the game can no longer “make and sell.”

Remember FFELP?

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The evolution of underwriting private student loans

School eligibility takes on new significance Lenders establish eligible school criteria based on:

• CDR thresholds

• Programs of study

• Geographic restrictions

• Graduation rates

• Retention rates• Accreditation “Whad’ya mean Faber’s not on

your eligible school list?!?!?”

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In summary…..• Conditions are slowly improving; private student loan lenders

are gaining confidence in the market• Fixed rates, at or below PLUS• Many loans now carry zero fees; repayment benefits• Forgiveness policies similar to PLUS

• Caution still rules the road• Strict underwriting guidelines will continue• Four-year schools still the primary market

• What to expect• Private lenders ready to compete on price vs. DL PLUS• More lenders will enter marketplace for 2012-13• Pricing will steadily improve; approval criteria won’t ease as rapidly

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Questions and discussion

Ben.Brudnock@CitizensBank.com 724-499-5822