The Pricing Spectrum

Contributing Writer

13 minutes

Designing deposit and loan products that stand out in the marketplace can encompass creative flair in pricing, especially now that there is a bit of play in the interest rate environment.

In recent years, credit unions have been forced to contend with rate compression, with pricing “bound by zero” as the lower boundary, says Neil Stanley, CEO and founder of The CorePoint, Omaha, Neb. As rates begin to rise, there will be more possibilities to price savings and loan products in a way that sets them apart from the competition.

“Certainly a rise in rates will bring pricing as a science and art more into focus for financial institutions,” Stanley notes. “Credit union managers may see opportunities to do things with rates that they were intimidated from doing in the recent past.

“Pricing is the biggest missed opportunity in our industry because executives at most financial institutions feel inhibited,” he adds. “They haven’t been exposed to the breadth of price differentiation and value creation. They tend to view their own products as commodities. If that’s the case, members would be tempted to commoditize providers of financial services as well. They don’t always see the nuances of the various offerings so they may see them all as more or less the same.”

In contrast, he suggests that CU executives think about pricing as a spectrum, informed by both market rates and the value the CU adds in designing deposit and loan products to meet members’ needs and preferences. The market imposes a “reference rate,” and the higher that rate is, the more room the CU has for discretion in pricing decisions.

Getting Philosophical

One big picture issue is consciously agreeing on a pricing philosophy. Community banks generally focus on improving profitability, whereas CUs are typically viewed as promoting fairness through pricing.

“Credit unions want a disciplined pricing approach that is fair and efficient, and there needs to be a philosophy to guide that,” Stanley says. “It’s not just about pricing loans to be in the middle of a comparative sample. Executives need to understand” what they’re looking to accomplish with their pricing.

The philosophy at $1.1 billion CoVantage Credit Union is “to lend a little bit deeper for members” and to price based on credit risk and the rate environment, as opposed to a market comparison, says CUES member Charlie Zanayed, CSE, SVP/chief retail officer for the Antigo, Wis., CU serving 85,000 members.

For example, CoVantage CU will loan up to 125 percent of new car price for just 0.75 percent more than the rate for a loan with a 25 percent down payment. The CU will make loans for more than 125 percent of the car price at its unsecured loan rate, which stood at 6.24 percent in late December.

With its community development financial institution certification, CoVantage CU adheres to its commitment to serve the financial needs of low- to moderate-income members by offering relatively low rates as an alternative to finance companies and banks charging “whatever the market will bear,” Zanayed notes.

This commitment also extends to offering the type of credit lower-income members want and need, he adds. Last October, for example, CoVantage CU made 503 unsecured loans of $1,000 or less.

“You don’t really make money on those kinds of loans, but you are serving members’ needs,” he says simply. “But if you serve a niche of people that others are ignoring and you do so responsibly, you can make money. We try to do well by doing good.”

Members respond by paying their loans: The CU’s 60-day delinquency rate as of third quarter 2015 stood at 0.45 basis points. And the CU made enough money to “pay patronage,” or return to members, $2.1 million in 2015, a 22 percent increase over the previous year.

The CoVantage CU philosophy to offer favorable rates to members is reflected in another aspect of its auto lending. Though the credit union does offer indirect loans, it limits the dealer reserve fees it is willing to pay to build business through that channel, preferring instead to “pass on better rates to members, so that our rates are extremely competitive,” Zanayed says. “That allows our direct loan business to grow faster, up 10 percent in 2015.

“Some financial institutions are paying 3 percent on dealer reserve, which pushes up the average payoff to over two years,” he adds. “We prefer to compete on rate and speed of processing. You can give up a lot of margin on indirect loans, and you end up not being able to pass that back to members. We look at margin management holistically.”

As go Prices, so go Profits

Maximizing profit is not the sole aim of credit unions, but they must manage revenue production to maintain adequate levels of capital to grow the credit union. Pricing has the biggest impact on profit, Stanley notes. As business studies have shown, an incremental change in pricing has a much more substantial effect on profit than a corresponding reduction in costs.

“A one percent change in price of offerings has a much bigger impact on profitability than a one percent reduction in either fixed or variable costs,” he explains. “Many financial institutions have focused so intently on reducing their costs of production—and they needed to do that in this very competitive world—that it’s unlikely they’ll be able to squeeze much more out of costs.”

In setting prices for various products, managers also need to consider the range of preferences among members. Some value quick answers, an express lane for choosing their financial providers and products. Those products should be priced at a premium for that convenience. Other members have the time and inclination to shop more carefully and to examine and negotiate over details.

The medium also matters. If your strategy is to promote offers in mass advertising and Internet banners, you are choosing to position your products for self-selection by members as commodities where the lowest price wins. For example, many mortgage options have been commoditized to conform to secondary market standards.

An alternative is “to create value that goes beyond the commodity” by offering some options through consultations in which financial professionals engage with members individually, an arena that permits more refined pricing, Stanley says. This one-on-one approach addresses members’ individual circumstances and identifies solutions tailored to their needs.

“When people are working with their life savings, they tend to want some reference points. They want to talk with somebody about their options,” he says. “The vast majority of people, when managing substantial amounts of money, will want to get the reaction and ideas of others as they do that.”

The CorePoint has structured a product designed to appeal to rate-shoppers, providing credit unions with a tool to retain maturing CD funds at reasonable rates. The Limited Edition Savings account offers rates similar to CDs, but without term commitments or early withdrawal penalties. As a product designed to defend deposits, not attract new money, it is only offered in consultation with members who are obviously weighing their options for a maturing certificate.  

This tactic of differentiation is useful in serving the needs of a “vocal minority” of members who take the time to call in or stop by looking for a better deal. “You have to understand, ‘What’s our boundary in dealing with these members?’ That’s when it helps to have pricing in place that is scalable,” Stanley says.

Attention all Savers

$4.7 billion, 297,000-member Patelco Credit Union has launched two savings products exemplifying creative pricing. The Money Market Select Account, introduced in March 2015, is designed to bring in new deposits with a reverse-tier strategy that especially rewards smaller savers. The account pays 3 percent on balances of $2,000 or less, 2 percent on funds in the next tier up to $5,000, 1 percent in the third tier up to $10,000, and so on, up to a 0.2 percent return for funds above $100,000.

“We wanted to grow assets, and at the same time, members were saying, ‘You’ve got great loan rates, but what can you do for savers?’” says CUES member Melissa Morgan, chief retail officer of the Pleasanton, Calif., credit union.

“Typically, the more money you have to invest, the higher rate you can find,” she notes. “We decided to be somewhat disruptive and do the opposite.” The strategy generated positive feedback and provided motivation for members to focus on growing their savings. Patelco CU settled on a money market account in response to members’ preference to remain liquid amid so much uncertainty over market conditions and interest rates.  

“We are committed to helping our members improve their financial health and resiliency. One of the best ways to start is by setting aside liquid funds for emergencies,” she explains.

Overall, deposits grew by $363 million in the 10 months after introducing this option, which accounted for the majority of new deposits. The Money Market Select Account has been popular with new members, with existing accountholders who automatically got the new rates, and with members who moved their money from other financial institutions where it had been “sleeping on the sidelines,” Morgan says. In addition to funding their own accounts, parents and grandparents opened accounts for their children and grandchildren to get the great rates.

Act 2 of Patelco CU’s novel savings options is a Rising-Rate CD, introduced in October in anticipation of the Federal Reserve’s year-end rate increase. “Our commitment was to be out in front of any rate increase,” she says.

The certificate, with a rate that rises annually regardless of what’s going on in the market, is designed to appeal to savers who might be waiting to see how rates change. “We take the guess work out of attempting to time rate changes,” Morgan says.

Before offering its remarkable savings rates, Patelco CU was very careful about managing its exposure, she adds. “We built in protections by hedging with our investment portfolio and carefully monitoring the impact to our overall portfolio. At the end of the day, we are giving our members two great reasons to build their savings and improve their financial health at Patelco.”

Care in Pricing Loans

On the lending side, CUs need to take care with rate differentiation to avoid even the appearance of disparate treatment of members in protected classes, Stanley says. The key is to stay focused on members’ behavior, not demographics or geography, the latter of which may create the appearance of red-lining.

 “The question becomes, ‘What can credit union managers do to get more of the rates they want?’” Stanley says. The answer lies in “structural negotiation,” or the presence of many variables that allow a wider range of offers. This range is greater in commercial loans as business members present a variety of collateral positions, balance sheets, and borrowing needs. Every business loan offers a unique risk-reward profile and thus can be priced individually.

“If an organization ever says that it prices fairly because it offers everyone the same rate, that is the exact opposite of fairness,” he contends. “The result is adverse selection. If you offer a narrow price range, you will attract most what you least want. When it comes to credit, offering one rate today for a business loan, say 4 percent, may attract the most marginal borrowers, who don’t have a lot of options to shop elsewhere. Distressed borrowers think the rate is great, and everyone else thinks it’s too high.”

Heading off a new Competitor

Departing from a typical approach to pricing personal loans may help CUs respond to an emerging competitive threat from peer-to-peer lenders like Lending Club, suggests CUES member Bill Vogeney, senior EVP/lending/finance with $4.3 billion, 240,000-member Ent, Colorado Springs.

Early on, Lending Club catered to credit-challenged borrowers, but recently has been reaching out to consumers with good credit, he notes. Other online lenders are widening their reach, such as SoFi’s shift from refinancing student debt to sending competitive prequalified credit offers to a broader audience.

“These marketplace lenders are a threat to credit unions, and how are we responding?” Vogeney asks. “The average lowest personal loan rates offered by credit unions are still above 10 percent.”

In 2012, Ent decided to lower the rate on personal loans to increase overall portfolio yield; the rate for members in higher credit tiers declined from 10.9 percent to 7.5 percent. Within 60 days, monthly volume grew from $600,000 to $2.5 million. When the CU tested a prequalified personal loan offer with mobile and online fulfillment and front-line promotional support, volume rose to $4 million monthly. The “new normal” is in the $3 million to $3.5 million range.

According to its marginal pricing model, Ent needed to increase loan volume by 50 percent to recoup the revenue from lowering the rate, so this strategy has definitely been a money maker, Vogeney says. And the increase in personal loan volume helped achieve a three-year goal to increase the loan-to-share ratio from 71 percent to 80 percent in just one year. It’s now 91 percent.

The CU’s delinquency rate as of Dec. 31 was 0.32 percent over 60 days past due. The net charge-off rate for the 12-month period ending Dec. 31 was 1.15 percent.

These types of strategies can provide a boost to net interest margins stymied in a low-rate environment. “We’re probably an outlier in that we’ve seen net interest margins increase over the last 18 to 24 months. It is possible to lower rates and drive sufficient volume to produce marginal income,” Vogeney says.  

Getting Back in the Game

Before the Great Recession, shopping for the best rate on deposit accounts was common, but when deposit rates dipped and remained near rock bottom for years, many consumers decided comparing rates wasn’t worth their time, put their money in a safe place, and became complacent, Stanley says.

In prerecession times, a $1 million nest egg might have produced $80,000 to $90,000 annually in interest compared to the current $10,000. “Many people who thought they had a nice nest egg have been forced to begin redeeming the principal,” he says. “As rates start to rise, will people start to take notice? Maybe they’ll decide it’s worth their time and energy to begin comparing rates again.” To capture the attention of those consumers, he suggests “dollar-izing” the offer (spelling out the actual return members will earn, such as the interest to be paid on a one-year CD, in dollars and cents) to make it more relevant and transparent.

CUs also can encourage members to “refinance their CDs” currently held with other financial institutions. Refinancing loans as rates decline is common, but the idea of refinancing assets as rates rise is likely novel for many. A blanket offer to pay early withdrawal penalties might get expensive, but your CU could calculate the higher return on certificates with higher rates to show members that they could cover the costs of those tax-deductible penalties and still earn more by “trading up,” Stanley notes.

Other key strategies:

Make sure all time deposits automatically renew at standard rates, not special introductory rates.

In a rising rate environment, consider strengthening early withdrawal penalties to maintain the business you’ve brought in with rate specials.

Give members several options in the loan and savings rate structure.

“The typical approach of lenders is to keep it simple, and I appreciate that,” Stanley says. “But the more we learn about the psychology of pricing, we discover that choice is essential to produce confidence. If you give members three choices, each of which has merit—such as a loan with a fixed rate, a variable rate tied to treasury notes, or a variable rate tied to the credit union’s internal index with a ceiling—that engages members to use their power of choice. And when they exercise that choice, they satisfy their need to shop and deepen their relationship and buy-in with the credit union.”

Karen Bankston is the proprietress of Precision Prose and a longtime credit union writer.

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