Private loan underwriting……... Understanding how lenders weigh the risks

1. Private loan underwriting……...Understanding how lenders weigh the risks Ben Brudnock Vice President Education Finance Citizens Bank

2. Session topics • Types of Consumer Loans • Impact of recession on credit underwriting • Underwriting basics • Factors that determine loan approval • Counseling advice • Private student loan evolution • Q&A

3. Types of Consumer Loans • Mortgages • Home Equity, Home Equity Line of Credit (HELOC) • Auto – RV – Marine – Motorcycle • Student Loan (federal or private) • Payday loans • Credit Cards • Personal loans against assets

4. Impact of the recession on credit underwriting • Root cause of the recession: Mortgage defaults • 5.4 million of 45 million (12.07%) mortgages nationwide were delinquent or in some stage of foreclosure during QI 2009 • Nearly 3 million homes foreclosed on during all of 2009 (1 in 45 homes); more than 2x number in 2007 • Mixed signs of recovery: • Only 2.2% of current mortgage balances transitioned into delinquency during 2Q 2011 • Total household delinquency rates have dropped for six straight quarters; now 9.9% • However, mortgage originations over last four quarters were 44% lower than 2003-2007 averages • Approx. $1.1 trillion of consumer debt is currently delinquent Source: Federal Reserve Bank of New York

5. Impact of the recession on credit underwriting • Faced with mounting losses, lenders (except Direct Loan PLUS) tighten standards on new loan applications • How? • Higher minimum qualification standards (i.e. credit score, income, co-signer requirements, etc.) • Longer historical look into personal finances • Increased pricing (fees and margins) • Exit the marketplace altogether

6. Impact of the recession on credit underwriting Office of the Comptroller of the Currency (OCC), a division of the U.S. Treasury Department, publishes an annual survey of Credit Underwriting Practices. Those surveyed included 54 of the largest banks in the country with assets of $3 billion or more. 17th Annual Survey results include: Credit Underwriting Practices: Commercial Products 2006 2007 2008 2009 2010 2011

7. Impact of the recession on credit underwriting Credit Underwriting Practices: Residential Construction 2006 2007 2008 2009 2010 2011

8. Impact of the recession on credit underwriting Credit Underwriting Practices: Overall retail products 2006 2007 2008 2009 2010 2011

9. Underwriting basics Definition: Loan underwriting is the process a lender uses to determine whether the risk of lending to a particular borrower under a particular set of circumstances is acceptable.

10. Underwriting basics • Automated underwriting functions • Credit Scores • Credit History • Credit Utilization Ratio • Manual (or semi-manual) underwriting functions • Minimum income requirements • Employment history • Debt to Income ratio (DTI) • Loan to Value ratio (LTV) • Down payment • Collateral / Appraisal

11. Loan approval factors: Credit Scores • FICO or Credit Scores • Fair, Isaac and Company • Developed the algorithm used by most credit bureaus to calculate a credit score • A FICO score is the most commonly used credit rating • Credit scoring is a quick, objective & consistent method for lenders to measure the “risk” of an applicant • Scores based solely on information in consumer credit reports maintained at the credit reporting agencies (Experian, TransUnion & Equifax) • The higher the score, the lower the risk

12. Loan approval factors: Credit Scores • These percentages are based on the importance of the five categories for the general population. • For particular groups – for example, those who have not been using credit for long – the importance of these categories may vary. Source: www.MyFICO.com

13. Is there an average credit score? • According to Experian, • the current national average credit score is…. • 694 • Notes: The average credit score in PA is 705 • Highest state avg: 721 • Lowest state avg: 670 • Can you guess the states?

14. Loan approval factors: Credit history • Lenders may screen for both the length and usage of credit • Trade lines (individual credit accounts: balances, account status, date opened, credit limit, etc.) • Credit inquiries (a list of everyone who has accessed your credit report during the past two years, both voluntary and involuntary. • Public record and collection items (public record data from collection agencies and courts; info includes liens, judgments, bankruptcies and wage garnishments)

15. Loan approval factors • Debt to income (DTI) ratio • How a DTI is determined: Monthly household liabilities divided by monthly household gross income = DTI (Also known as back-end/before mortgage DTI) • Example: $3500 monthly bills / $10,000 gross monthly income = 35% DTI What’s good? DTI less than 28% What’s so-so? DTI between 28-36% What’s not so good? DTI greater than 36%

16. Loan approval factors, cont. • Income requirements • Verification of stated income • Minimum income requirements • Employment history • Length of time with current employer • Document history of full-time employment (references) • Credit Utilization ratio • Percentage of available credit currently in use • Difficult to determine the right mix

17. Loan approval factors, cont. • Down payment • Good sign of applicants ability to save • 20% of mortgage loan value can avoid PMI insurance • Property – asset appraisal • Loan to Value (LTV): loan amount / purchase-appraisal price • Interest rates on Home Equity loans are often tied to LTV percentages • Co-borrowing • Mandatory for approval when applicants have little to no credit history and/or income • Can often lead to better rates-fees compared to loans with one creditworthy applicant

18. A recipe for loan approval success • Solid credit history • No instances of adverse credit / collections for 7 years • Little to no “minor” adverse credit instances • Above average credit score • Best rates & fees for those with 725 or higher FICO • Verifiable income & low DTI • Current & prior year W2’s and DTI less than 30% • Borrow jointly • Two creditworthy co-borrowers and better than one

19. The evolution of underwriting private student loans That was then…………… Approvals often based solely on FICO Direct to consumer loans widely available to students without a co-borrower Best interest rates were lower than Prime Private loans made widely available to schools below bachelor’s degree level Originating lenders could easily securitize loans for additional funds 2007 AD

20. The evolution of underwriting private student loans And this is now…………. FICO is vital, but only part of equation Direct to consumer loans are all but gone While interest rates are low, margins are much higher Associate level & below schools have limited private loan availability Securitization market is weak for student loans; lenders still in the game can no longer “make and sell.” Remember FFELP?

21. The evolution of underwriting private student loans • School eligibility takes on new significance • Lenders establish eligible school criteria based on: • CDR thresholds • Programs of study • Geographic restrictions • Graduation rates • Retention rates • Accreditation “Whad’ya mean Faber’s not on your eligible school list?!?!?”

22. In summary….. • Conditions are slowly improving; private student loan lenders are gaining confidence in the market • Fixed rates, at or below PLUS • Many loans now carry zero fees; repayment benefits • Forgiveness policies similar to PLUS • Caution still rules the road • Strict underwriting guidelines will continue • Four-year schools still the primary market • What to expect • Private lenders ready to compete on price vs. DL PLUS • More lenders will enter marketplace for 2012-13 • Pricing will steadily improve; approval criteria won’t ease as rapidly

23. Questions and discussion Ben.Brudnock@CitizensBank.com 724-499-5822