Are affordable payday loan alternatives viable for credit unions to deliver?

Presentation by Gareth Evans: Financial Inclusion Centre Welsh Credit Union Conference (Cardiff) – Thursday 17th July

What is a payday loan?

• • •

Despite the name a payday loans are just small, short-term unsecured loans.

It doesn’t matter whether the repayment of loans is linked to a borrower's payday Typical amounts are £300-500 paid pack over 1 month or earlier

Is this too far from what is already being offered by many credit unions?

Threat or opportunity?

• • • •

Huge market - Financial year 2012:

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£2.8 billion lending

•

1.8 million customers (5.7 loans per user).

•

10.2 million new payday loans.

Between 2011-12 – loan volume increased 35% and loan value 45% 70% by the big three – Wonga, MoneyShop and QuickQuid.

80% Payday customers apply online (35% of all new customers via lead generators)

Threat or opportunity?

•

Payday lending in Wales – approximately 3% of PDL market:

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£84 million lending

• • (total interest = £25million + total rollover interest/fees = £31million)

54,000 customers 306,000 new payday loans.

Do credit unions want a piece of the market and can we set ourselves apart?

Threat or Opportunity?

• • • • • • Short-term lending is nothing new.

Taken off due to greater demand and technology (we have we let in competition as too slow to make decisions / transfer funds). Members already borrowing from payday lenders.

Makes decisions on lending to them riskier – multiple loans indicate inability live within means.

Many potential members getting into trouble and want to consolidate.

Lenders moving into longer term loans

So why aren't we competing:

• • • • •

Challenges delivering viable payday loans:

Fundamental barrier has been interest rate cap (26.8% now 42.6%) - financial returns make such short-term, high risk loans immediately unprofitable. IT infrastructure to deliver instant online application / assessment / dispersement platform.

Capital for lending (less of an issues amongst CUs). Capacity and capability of credit unions.

Inclination / aspirations to deliver.

Why LMCU established a payday loan product:

• Meet the borrowing needs of existing LMCU members - shown to be using high cost payday companies.

• PDL product would attract new members using payday loan ‘banner’ and would go on to become long-standing members who use the range of services offered by LMCU.

LMCU payday loan scheme:

• •

Model for alternative payday lending through credit unions:

‘Loss leader’ model – knew that it would loose money.

‘Gateway’ product for new members Pilot project funded by:

Retain ‘positive’ characteristics of payday loans:

   Accessible and convenient online access 24/7 Simple and quick application forms Sophisticated credit assessment enabling instant decisions  Instant transfer of funds – transfer fee (£11) or paid via BACS (free).

Design out ‘negative’ characteristics:

X Affordable – Interest at 26.8% APR (now 42.6% APR) on the declining balance (£3/£100). Compared to average £30/£100.

X Affordability checks - new applicants must be employed, earning more than £12Kpa and a current account.

X Flexible repayment period over 1, 2 or 3 months. (Subsequent loan up to £1,000 over 6 months).

X Repayments taken automatically from the borrower’s bank account on the agreed date(s) – not sporadic CPAs X X No rollovers or late payment penalties (int continues).

Access to sustainable/longer term credit and debt advice.

Pilot Evaluation:

• • • Measure the success of the pilot project between launch February 2012 preceding 12 months.

Quantitative analysis of LMCU data recorded during the payday lending pilot to: – Examine actual performance.

– Profile new and existing borrowers.

– Assess subsequent patterns of financial service usage amongst new members to help determine the actual cost implications of delivering such a payday loan product. Consultation with LMCU payday loan users: – Surveyed 210 borrowers (17%) on attitudes and behaviours towards the payday lending and LMCU service.

Payday loan pilot performance:

• •

Proved extremely

popular - 6,087 applications received (or 500 pm) for £1.5m (average requested loan amount of £238)

2,923 payday loans approved with a value of £688,000

to 1,219 different borrowers.

Payday loan pilot performance:

• •

Average of 2.39 payday loans per borrower (62% repeat) –

industry = 60% repeat & 3-4 loans with same lender Applicants liked flexible loan repayment terms.

Payday loan pilot performance:

Attracting new members:

• Median Income (after tax) - £1,576pm / £18,912pa • Income brackets: – Tier 1 (Above £23K AfT) = 26% – Tier 2 (£13K-£23K AfT) = 58% – Tier 3 (Below £13K AfT) = 16% • 9.8% homeowners

Payday loan pilot performance:

• Delinquency levels relatively low: – 6.3% of all LMCU PDL (or 5.2% of total lent) being at least one month in arrears – 1.6% of all LMCU PDL being over 3 month in arrears – Arrear levels amongst new members much higher (12% - 4.8% 1month / 4.4% - 0.8% of LMCU PDL 3month).

• Compared to between 28% (OFT) or 35% (Competition Commission) delinquency in rest payday loan industry – where loans being rolled over.

Savings for LMCU PDL borrowers:

• •

An affordable PDL product has the potential to save significant amounts for borrowers.

– Average PDL £265 charged at £25 /£100 borrowed. – This typical loan repaid over 1 month would therefore cost at least £66, compare to just £5.30 with LMCU.

By borrowing through LMCU, the 1,219 members collectively saved £145K in interest charges alone

(£119 p. borrower or £50 p. loan)

Saving for Welsh households:

• •

Payday lending in Wales in 2012 cost welsh consumers:

• total interest = £25.2million

• total rollover interest/fees = £31.0 million

If PDL lending via LMCU at 42.6% APR:

• total interest = £2.52million

• total rollover interest = £396,900

Annual saving to welsh households = £53.2 million

Preventing future PDL use:

•

74% of borrowers had previously taken average of 3.2 loans over 12 months before their first LMCU PDL

– Worryingly, 17% of these had taken six or more loans.

Preventing future use of PDL:

• • • •

Payday lending through a CU is an effective way of

diverting away from high cost lenders – 2/3 LMCU users unlikely to borrow from other PDL companies again.

Primary reason for borrowing through LMCU was the low cost (66%).

• Others liked it was offered by CU(19%) and longer repayment option (10%).

Satisfaction levels were very high with 74% very

satisfied and 24% fairly satisfied. All those payday users surveyed were willing to recommend friends/family.

Subsequent use of LMCU services:

•

CU membership encourages recent joiners to build financial resilience through the accumulation of savings.

• Almost £18,000 accumulated by 331 new members – a £53 per member (£95 for new member who had been with LMCU for at least 9 months). •

Quarter of new members opened a CUCA with LMCU

•

Initially attracted by access to short-term credit but 27% of the 331 went on to take out longer-term loans.

• LMCU lent an additional £90K in non-payday credit (generating over £15,000 in interest) – an average of £1,044 over 17.9 months. •

Longer-term loan usage increases dramatically with membership.

• Over 40% of new members with at least 6 months membership take out a longer term loan (52% with at least 9 months).

Financial viability of PDL product

• •

Estimated income from delivering PDL product: Each PDL generates an average income of £12.02 (total income £35,142)

• 77% of this revenue is from loan interest (or £9.23 per loan), 21% from the option for instant transfers (£3 per transfer) and just 2% from joining fees (£2).

Additional net profit generated from new members taking out additional longer-term loans was approximately £13,000 or equivalent to £40.16 for every new member.

• Those who joined the credit union within the first three months of the pilot, each generated the credit union approximately £87.51.

Financial viability of PDL product

• •

Estimated cost of operating the PDL product: Each PDL costs an average £11.99 (total expenditure £35,058)

• LMCU estimates cost for making a first loan is £18.57 but repeat loans are £4.00 as fully automated and requires no external checks.

• Additional costs of over £4,500 to administer refused or ineligible loans.

Just over £15,000 during the pilot was

determined as delinquent together with over £400 in credit control costs.

Financial sustainability of an alternative PDL product

• •

Payday pilot not financially viable at the point of

evaluation - pilot generated an actual loss of £6,725 (£2.30 for each loan) Model is financially sustainable when additional income generation levels projected for new members with LMCU for at least 9 months: •

Would actually realise a net profit of at least £8,950 or £3.06 for every loan

Financial sustainability of an alternative PDL product

•

Modelled the effect of April’s interest rate

increase to 42.6% APR (£100 borrowed for 1 month cost £3 (rather than £2): • Increased profit margins would have resulted in £9,311 profit or £3.19 per loans (with additional income from use of other LMCU services).

• OR projected overall net profit of £25,000 if all new members generated additional income as identified amongst 9 month membership

What Next?

• • • • LMCU continued the payday loan product Now almost 10,067 loans and £2.63 million lent saving – current £565,000 in interest. New members - 1,040 taking 2,227 loans Second evaluation (hopefully!) – 2.5 years lending evidence.

Questions and debate?

• Should we be operating within the payday loan market?

• Is this the right product for credit unions? • How do we scale the product to provide greater coverage?

Gareth Evans

Associate Research Manager

Financial Inclusion Centre

E: [email protected] W: www.inclusioncentre.org.uk

Payday loan customers

• Median net household income - £24,000 • 70% need a loan due to change in financial circumstances.

• Reason for borrowing: • Living expenses (50%) • Car/vehicle expenses (10%) • Clothes/household items (7%) • Holiday (4%) • Pay off other (non payday) debts (4%) and Repay another payday loan (2%) • Rent/mortgage (4%) • Socializing (2%) • 60% of new customers take out a further loan with same company (and will take out 3-4 additional loans in same year) • 40% say could not have used alternative lending source • 29% turned down for credit in last 12 months