Fewer than one in five credit union members have their auto loan with the credit union. The simplicity of financing at the dealership often eliminates the additional step consumers would need to take to obtain financing. Having credit union loans available to them at the point of sale provides a service to all parties. This third-party indirect lending is one way for credit unions to increase their market share of auto loans, but managing the associated risks is the key to a successful program.
All loan programs have a unique set of risks, and third-party indirect lending is no exception. When considering a contract with a particular vendor, the following practices should be implemented:
- Evaluate the third-party vendor’s underwriting criteria and establish agreeable policies and practices
- Place limits on their authority to modify loan terms
- Make sure performance standards and an exit clause are included in contractual agreements
- Thoroughly test all assumptions in the vendor’s model
Once an agreement has been made, a second level of risk management begins. Third-party indirect loans are written on the ‘front line,’ but that does not release the credit union from its obligation to continually monitor and evaluate the program. A set of internal controls should be established at the onset of the program for both the actual loans and for the vendor conducting the lending. Credit unions must screen them as stringently as they would their in-house loans. This process can be just as time consuming and expensive. The following are some of the practices to consider at this stage:
- Require regular reporting
- Regularly test for compliance with the contract terms
- Have an expert in the field audit the book of business
- Perform static pool analysis to spot problems
- Calculate returns and compare to projections and previous results
- Consider executing the exit clause of your contract if results do not meet your expectations
Indirect lending can also include levels of subprime loans (lending to borrowers with weak credit histories). This carries an additional risk of historically higher default rates. With an extra level of control required, credit unions must ensure concerns are identified immediately and that they have taken the appropriate actions. Terms of the underwriting limits for these subprime loans should be determined at the time of contract with the vendor.