Learning from the London Mutual Credit Union’s Payday Loan Pilot. Can the alternatives be affordable and viable?

CfRC Tackling the Payday Lenders Conference Gareth EvansAssociate Research Manager

LMCU payday loan pilot scheme:Challenges to credit unions delivering viable payday loans:•Fundamental barrier to delivering PDL product has been interest rate cap (26.8%) - financial returns make such short-term, high risk loans immediately unprofitable. •IT infrastructure to deliver instant online application / assessment / dispersement platform.•Capital for lending •Capacity and capability of credit unions•Inclination / aspirations to deliver short-term lending

LMCU payday loan pilot scheme:Model for alternative payday lending through credit unions:•‘Loss leader’ model – knew it would loose money•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. •Meet the borrowing needs of existing LMCU members who shown to be using high cost payday companies.

Pilot project funded (£112,500) by Friends Provident Foundation and Barclays Community Finance Fund. LMCU funded lending capital.

LMCU payday loan pilot scheme:

LMCU payday loan pilot scheme:Retain ‘positive’ characteristics of payday loans:Accessible and convenient online access 24/7 Simple and quick application formsSophisticated credit assessment enabling instant decisionsInstant transfer of funds – transfer fee (£11) or paid via BACS (free).

LMCU payday loan pilot scheme:Design out the ‘negative’ characteristics:XAffordable – Interest charged at 26.8% APR on the declining balance of the loan (£2/£100). Compared to average £25/£100. XAffordability checks - new applicants must be employed, earning more than £12Kpa and a current account.XFlexible repayment period can be over one, two or three months. (Subsequent loans can be for up to £1,000 payable over six months).XRepayments are taken automatically from the borrower’s bank account on the agreed date(s) – not multiple CPAsXNo rollovers or late payment penalties (interest continues).XAccess to more sustainable / longer term credit and 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 of 1,219 borrowers to identify their attitudes and

behaviours towards the payday lending and LMCU service

Actual performance of the payday loan pilot:• 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.

Actual performance of the payday loan pilot:• Average of 2.39 payday loans per borrower (62% repeat)• Applicants liked flexible loan repayment terms.

Actual performance of the payday loan pilot:

Actual performance of the payday loan pilot:

•Delinquency levels relatively low with 6.3% of all LMCU PDL (or 5.2% of total lent) being at least one month in arrears•Arrear levels amongst new members over twice the level of existing members (12% - 4.8%).•Compared to 28% delinquency in rest payday loan industry – where loans being rolled over (OFT).

Savings for PDL borrowers:• An affordable PDL product has the potential to save

significant amounts for borrowers. • Average PDL £265 charged at £25 per £100 borrowed (OFT). • This typical loan repaid over one 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 per borrower or £50 per loan). • If 8.2million PDL in 2011/12 from high cost lenders had

been through a CU, £749 million would have been collectively saved (or £91.43 per loan).

Preventing future PDL use:• 74% of LMCU PDL borrowers had taken average of 3.2 over 12

months before their first LMCU PDL• Worryingly, 17% of these had taken six or more loans.

Preventing future use of expensive 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. • Rises to £95 for new member who had been with LMCU for at least 9

months. • Quarter of all new members opened a current account 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 out an additional £90,000 in non-payday credit, which will

generate over £15,000 in interest – borrowing an average of £1,044 over 17.9 months.

• Longer-term loan usage increases dramatically with membership. • Over 40% of all new members with at least six months membership take

out a longer term loan• Increases to 52% with at least nine months of membership.

Financial viability of PDL productEstimated income from delivering payday loans:• 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 payday loan 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 be 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 £3.55 (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 over 6,000 loans and £1.4 million. • Significant interest from credit union movement

for usage (but not for everyone)• LMCU working with ABCUL to utilise IT

infrastructure for other CUs to operate. • Need other solutions for holistic national solution

(CDFI?)

Gareth Evans Associate Research Manager

Financial Inclusion Centre E: gareth.evans@inclusioncentre.org.uk W: www.inclusioncentre.org.uk