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 £ 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) million new payday loans. Between – 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 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: W:

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