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

Presentation by Gareth Evans: Financial Inclusion CentreWelsh 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:

• £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:• £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 No rollovers or late payment penalties (int continues).X 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 productEstimated 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: gareth.evans@inclusioncentre.org.uk 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