Lending is an art

An excerpt from More Passion for Lending written by A. Rex Johnson:

Lending is an art. Never forget that. Lending is not engineering. It is not learned by mastering formulas. It is not well practiced by applying rote rules. Lending is founded on common sense tempered with an understanding of people. It is a skill that is learned over time. It calls for applying the very human skill of judgment.

There has never been a computer built that can make the kinds of decisions needed to make good loans. There never will be a computer built that will be able to make as good loans as a man or a woman. Lending is a human business, and it is more fun as a human business.

It used to be that you made loans on the 3 Cs; Collateral, Character, and Capacity. Those were in the Good Old Days. You used to sit down with a member, talk with him, and evaluate him. Many times, you knew him personally or you knew the persons who knew him.

These days that kind of closeness is next to impossible. But that hardly means you have to surrender to computer scoring guides and cold-blooded ratios.

At our Baxter Credit Union, we try to bring back the closeness, to approximate the face-to-face meetings of the past. What we try, and what you should, too, is getting a “picture” of the applicant from the application and the credit report.

We believe that everyone is different. We try to get a human feeling for whom we are dealing with and make a judgment from that, not from mechanical and lifeless numbers. We see if our applicant is married or single, renting or buying his residence, young or old, new to the city or not, a frequent job changer or not, a person whose skills are easily transferred or not, and so forth. We try to get a feeling for this person. We blend all the characteristics together in our minds as a foundation for making a decision.

Then we use our judgment. In most cases, we almost immediately feel a very high comfort level in approving a loan. Applications of this sort we call ‘No Brainers’ and we move them along as quickly as we can. Other times our “picture” of the applicant makes us hesitate. We think a little harder: we may dig for more information.

But we go about our lending using judgment, not hard rules, and it has worked well for us. It can work for you, too. Acquiring the proper judgment takes training and experience. But it can be taught.

When you acquire that judgment, you will be able to see loan opportunities you previously missed, to make more and better loans than in the past, to build your Visa and Master­Card programs, and to slash your delinquency rate.

Remember, when you teach guide­lines, you can only be certain of one thing—that your employees will follow guidelines.

Ten key factors in granting loans

We teach our people to look at an application and the credit report and then to make a decision. That decision is generally based on the following ten factors.

1. Ability to pay

We look at the applicant’s income, and combined income if the applicant is married. We look at it as part of a whole. What we do not do is plug it into a formula such as a debt-to-­income ratio. We feel if we did that, our people would focus on formulas and miss the larger picture, which is really what we are searching for.

2. Intent to pay

We pull a credit report on every applicant. Some managers think credit reports are too expensive, but we do not. Sometimes we pull a second and third report from different credit bureaus.

3. Unsecured debt as a percentage of total debt

We take a very hard look at this. We add up the total debt and see how much of it is secured and how much is unsecured. We do not use a formula, but when we discover that the majority of the total debt is unsecured and the total debt is substantial, we regard that as a ‘Red Flag.’ When we see high unsecured debt and few or no assets, we also see a good candidate for bankruptcy.

4. Nothing bad is not good

These days, too many loans are granted to members who have no credit history, no assets and little time on the job. The lenders know essentially nothing about these members. They grant the loans because the applicants satisfy some mechanical standard such as a year on the job or a debt-to-income ratio of 40 percent. They make these loans because they cannot find a reason to tum them down. But this is not a good way to approve a loan. You need to know something good first. You can always find a way to turn someone down, such as a lack of credit references, no credit report or a job or residence instability.

5. Pyramiding debts

We look to see if the applicant’s debts have risen in the past twelve to eighteen months. We look for new debts and for credit cards that have been recently taken out. If we see that debts have been growing, we do not focus just on the payment history, which could have been excellent to this time. We compare the rate of debt increase to the rate of income increase. If debts are climbing faster, we see a problem, even bankruptcy.

6. Assets

Too many loan applications do not give enough information on assets. They do not reveal if the applicant is buying a house, what he paid for a house and what the house is currently worth. They do not reveal if the applicant has either equity in a car or savings. Persons with assets are less likely to declare bankruptcy.

There should be a relationship between an applicant’s indebtedness and his assets. If there is substantial debt and no real assets, then the applicant is a good candidate for bankruptcy. Focus on assets—they are key. And remember, if a member lives in a $100,000 house but owes $98,000 on it, he does not really have an asset.

7. Collateral

Always look for a way to make a secured as opposed to an unsecured loan. Your bottom line will soon reflect your wisdom. I do not mean to say that you should not make signature loans. I encourage you to do so. But do not make them the core of your business. Credit unions for too long have been the lender of last resort. We have taken all the risks and we should not have to. The members who obtain large signature loans based on length of employment with low income have a high risk of going bankrupt.

Think about your own credit union. The highest rate you charge is the one on signature loans, and the members paying that rate are usually the ones least able to afford it. So you charge the least able members your highest rate and wonder why you have a problem. At our credit union, 70% of the loans are secured; only 30%, including our Visa program, are unsecured.

8. Job security

We think about the following: How likely is the applicant to be laid off? What skills does he or she have and are they readily transferable to another company?

9. Consistent lending policy

We have good consistency in lending policy because we make all of the loan decisions at the headquarters office. When credit unions do not do so and they have multiple branches, inconsistencies creep in that members can take advantage of.

When different branches or loan officers have differing criteria, the word soon gets around and marginally-qualified applicants flock to the easiest one to get a loan from. I did a consulting job for a credit union once that had six branches in the same town, and members who were turned down in one just drove to the next.

Poor loans are made when credit unions are not consistent. The best example is what I refer to as the Frequent Applier, like the Frequent Flier in the airline industry. Frequent Appliers know that if they are persistent enough that sooner or later they will get their loans.

10. Opportunities

Lastly, when we evaluate an application, we look for opportunities. We do not just fill out orders, because we are not waiters and waitresses. Rather, we are creative thinkers and salespersons. We review an application and in our attempt to get a “picture” of the applicant, we look to see what the member qualifies for and what he could use that he has not applied for. That might be something like our Visa card or a home equity loan to pay off other bills.

Often we can pay off competitors’ credit card balances that are climbing because of high interest rates and put the balance instead on our Visa with its lower rates. We pay off competitors’ auto loans and just about any other type of debt. We always try to make an arrangement that is both good for us and for the member, what we call a “Win-Win” situation.

“Fast forward 30 years; it’s amazing how little has changed. As his daughter, I have learned the fundamentals of interviewing and underwriting from the man himself. With all the advances in technology and competition from businesses my dad would not have even heard of, his core principles light the way for all of us to continue to serve the member. He always believed every member had promise and represented opportunity if we simply got to know them better and truly understood their struggles. At our company LSCI while we continue to teach key ratios, it is never lost that there is a face behind the numbers.” – Lorrie Wohlfeil, LSCI, The daughter of A. Rex Johnson