I was working as a field representative for an auto finance company one beautiful March day in Chicago. Yes, Chicago does have beautiful March days. It happens once every other year. I was looking for the car of 60-day account and located it in a Chicago police department parking lot. I immediately blocked the car with mine so it could not be moved. This was the old days, long before cell or car phones so I walked down the street to the pay phone to call the office. I was told to wait in my car and the tow truck will be there shortly. I remember sitting in the car for over a half hour, the sun was shining heating up the car and I nearly dozed off when I heard a knock on the window. A uniformed police officer standing outside my car asked me to move my vehicle so he could get his car. I got out of my car and this 22-year old who looked like a 17-year old told the middle aged officer that I was a representative from the finance company and the car was in our possession and we could not give it back to him.
He then told me he filed Bankruptcy, which was foreign to me since I have not been trained on Bankruptcies. The only thing I knew about Bankruptcy was that we transferred the file to another individual in the office who took care of it. I had no one to ask for guidance so I had to make a decision. I told him we are in possession of this vehicle and we can sort through the Bankruptcy issue later. He then asked me to follow him home and he will surrender the car at his house so he can get home and remove his personal property. I advised him I could not, however if he gave me his keys I would drive him home. That was a long 15-minute ride. We did not have a lot to talk about. We did verify the Bankruptcy and ended up giving him the car back two days later. My boss told me I made the right decision to take the car. A lucky guess on my part.
y first experience with Bankruptcy. Little did I know 30 years later I would be writing this article on Bankruptcy for a leading trade publication.
Bankruptcy never seemed fair to me, the masses pay a higher interest rates for the few who walk away from their debts. When looking at history I begin to understand. Before bankruptcy if a man owed and he could not pay, he and his wife, children or servants were forced into "debt slavery", until the creditor recouped losses via their physical labor. Now that I am older and possible wiser depending on whom you ask, I believe bankruptcy is a necessity in a civilized society. Sometimes life is not fair and the sooner we realize it the better off we are. Anyway it does not matter what I think, bankruptcy is here to stay.
Let’s look at bankruptcy from the eyes of the debtor. What is the bankruptcy experience like? How much does it cost? What benefits will the debtor receive? What paperwork is required?
Seventy percent of your bankruptcies will be a chapter VII. Chapter VII cost roughly $2,000 - $2,500. The debtor must fill our numerous forms including a list of creditors, the nature of their claims, statement of intent, schedule of income and anticipated income, list of assets, a detailed list of living expenses and a schedule of contracts and leases. They also must provide copies of tax returns and a certificate of credit counseling, usually obtained via the Internet. Once the paperwork is submitted a Bankruptcy petition is filed and the debtor receives a case number and is protected from creditors by the “Automatic Stay”. Between 20 – 40 days after filing of the petition The US Trustee will hold a meeting of creditors. The debtor is nervous until they find out no one showed up. Assets if any may be sold with proceeds going to the creditors. Approximately 90 to 120 days after the filing the member receives a “Discharge”. A Discharge means you no longer legally owe certain debts. That would be unsecured loans, deficiency balances on cars they surrenders and upside down amounts on real estate secured loans. Unfortunately for the debtor they still owe taxes, alimony, child support and some student loans. While this debt may be undesirable, it is not subject to the Discharge order.
Let’s do a cost benefit analysis. The cost of bankruptcy is approximately $2,000 plus twenty to thirty hours of gathering paperwork and meetings versus the benefit of getting out of paying your unsecured debt and upside down amounts on vehicles and homes. Keep in mind the benefit is tax-free. We recommend you look at the “benefit” in relation to annual gross income (AGI). How much is your unsecured loan amounts and upside down amount on secured loans in relation to your AGI? How much is manageable and is there a certain percentage that makes you a good candidate for bankruptcy? What would motivate you to want to go through the bankruptcy process?
Let’s looks at and example. Let’s say you are looking at a member’s credit report with $20,000 in unsecured debt, a $21,000 car loan and $100,000 mortgage. They opened up three new credit cards in the last 24 months and eighty percent of the credit limits are used. They have a ten-year credit history without missing one payment. Are they a bankruptcy threat?
If you are a credit reporting agency selling a bankruptcy predictor model you have to make a decision with this limited information. Remember my repo story when I had to make a decision without all the information / training I needed. I find it interesting that credit unions are spending a lot of money with credit reporting agencies on bankruptcy scoring models in an attempt to identify bankruptcy candidates. While I salute the effort, they cannot be accurate with the limited information available. They can only identify the amount of the unsecured debt; they do not know the negative equity positions on secured loans, or the debtor’s income.
Lending Solutions Consulting Inc. (LSCI) has a model that predicts bankruptcy with greater accuracy then other bankruptcy models. It is not even close because our model has much more information including equity positions of secured loans and income. We call it “HYLS” or “high yield lending strategy”. Some of our client’s say it should be named “how you lend smart”. Using HYLS in conjunction with proper training will eliminate “surprise bankruptcies”.
Going back to the example, the HYLS model would look at the debtor’s benefits of bankruptcy. We know the unsecured debt is $20,000. What is the equity position on the $21,000 car loan? If the car were worth $18,000 we would calculate the total unsecured loan amount as $23,000 ($20,000 in unsecured loans plus $3,000 in negative equity). If the member’s AGI is $50,000 or less you have a strong bankruptcy candidate. AGI of $85,000 or more and bankruptcy is not a threat as the member has the earnings to support $23,000 in debt. AGI between $50,000 - $85,000 is marginal.
Lets continue working on this example. Lets make the assumption the member is applying for a loan for a new car and earns $45,000 annually. You identified him as a prime bankruptcy candidate, so you need to turn him down, correct? Not so fast. The LSCI philosophy of lending is “the only reason a loan should ever be turned down is when we believe the credit union will not be paid”. Can you make a loan to this member that survives bankruptcy? You know the member will have trouble paying everyone, but will he pay you?
If you give him a car loan with an equity position on direct deposit you will get paid even when other may not. Remember our philosophy! That rules out a trade in as the member has negative equity in that car. Negative equity in a secured loan to a bankruptcy candidate is called a “mistake”. If you pay off that mistake you own the mistake. You don’t want to own the mistake. You can finance a car with a down payment. The member has 20% of their credit lines available to come up with a down payment. Bankruptcy attorneys have coached their clients on taking advances on unsecured debt to pay down secured debt prior to bankruptcy. Using available credit lines for a down payment is an extension of that concept. What does he do with the car he wanted to trade in? You can’t tell him what to do, however you can tell him that many people would surrender the vehicle to the lender. The lender may sue for a deficiency balance. Again you are not telling them what to do, however others have filed bankruptcy discharging the deficiency balance debt. Give him a car loan at a reasonable rate that will survive bankruptcy before he files and assist him with a credit card after bankruptcy to help him rebuild his credit.
Tell the member you want a relationship for life and are willing to help him through the good times and the bad. Many members biggest fear of bankruptcy is that no one will give the credit again. Put him at ease and let him know you are here for him.
If this member surrenders the car in Bankruptcy he will have to finance a new car after bankruptcy. Many lenders will be glad to help at 24% from banks and 18% from credit unions. Knowing what the debtor’s in interest rates after bankruptcy gives you a strong bargaining position on potential reaffirmations. A reaffirmation is a contractual agreement making your loan non-dischargeable. You may convince the debtor to keep your car because of the value of your rate. If they surrender your car and their 2.9% APR and buy a new car at 18% are they really saving money?
I want you to imagine a new member walks into your credit union and is speaking with a loan officer. He mentions he considered filing bankruptcy. Loan officers in 95% of America’s credit unions will be looking for the denial reasons, wanting to get out of the conversation as soon as possible. Well-trained Loan officers will be looking for a way to create a lifelong relationship. How does your loan officer react?
We are coaching our clients to develop relationships with bankruptcy attorneys. One credit union even leased out office space to an attorney. Let the attorneys know that you will be happy to finance cars to bankruptcy candidates before they file so they will get a reasonable interest rate. In addition, you will help them rebuild their credit scores. With proper coaching a person can have a 700 plus FICO score three years after the bankruptcy is discharged.
In one of our meetings with an attorney we learned something lenders were doing that irritated him. The old school part of me was delighted we irritated him. The new school part of me looked for opportunities. He was upset that mortgage lenders were not reporting “paid as agreed” to the credit reporting agencies after bankruptcy. We immediately told the attorney that we would be happy to refinance those loans to help their clients rebuild their credit scores. We also added this to our presentation to other attorneys. Let the attorneys know that you will give their business cards to our members who are bankruptcy candidates.
Remember the old days before indirect lending when auto dealers were no friends of credit unions? They would give out misleading or sometimes false information about the credit union in an attempt to get the financing. They controlled the point of purchase and won most of the time. Today, auto dealers are valued business partners that many credit unions could not live with out. I see bankruptcy attorneys taking a similar path.
With the proper philosophy, training, tools and relationships, bankruptcy can be a big asset to your credit union. This is a huge opportunity for credit unions to prosper in a low interest rate environment. Follow these steps:
1. Implement the lending philosophy: “the only reason we will deny a loan request is because we feel the credit union will not be repaid”.
2. Provide training to your loan officers. Make them experts in bankruptcy, making bankruptcy proof loans, FICO scoring model, credit score enhancement services. LSCI can help you with this.
3. Use the LSCI HYLS model to predict bankruptcies. You can cancel the bankruptcy models from the credit reporting agencies. They do not have the critical information.
4. Develop partnerships with bankrupt attorneys.
I have time available this fall and would love the opportunity to come in and work with your staff. I can help them think “outside of the box” and have a favorable outcome on your net income. We offer a money back guarantee if you are not completely satisfied.
Have a great lending month!
Bob Schroeder, CLE
Vice President / Consultant
Lending Solutions Consulting Inc.