Many traditional aspects of indirect automobile lending have changed in recent years. The captive finance companies of automobile manufacturers have made the auto lending business more difficult for credit unions. In an effort to compete for automobile loans, many credit unions have tried to match the financial concessions of competitors by relaxing underwriting standards and cutting corners on processes and procedures. As a result some credit unions are operating in the highly competitive market with weak controls and lax loan underwriting programs, with predictable consequences. Further, it should also be noted that even credit unions with stronger programs are susceptible to diminishing collateral values and increased risk as loan terms are extended over longer periods.
Traditionally, the Department and credit unions have relied on a delinquency-based approach to evaluate automobile loan portfolios. This approach has served regulators and credit unions well in the past, but recent automobile financing trends require a more in-depth analysis when loan and collateral values are not correlated, vehicles are financed multiple times, or losses are deferred and embedded in loan balances.
This guidance reminds credit unions of certain aspects in the process that should be followed to prudently manage the risks associated with indirect loans. While there are benefits to a well-run indirect lending program, an improperly managed or loosely controlled program can quickly lead to unintended risk exposure. It takes proper planning and adequate controls and monitoring to make this type of program profitable and a productive activity for serving credit union members.
Credit unions develop indirect automobile lending programs by establishing relationships with automobile dealers. Credit unions define the type of borrower and loan they will accept by providing dealers with underwriting and interest rate guidelines. In many cases, a dealership gathers credit information from prospective buyers, completes loan applications, and forwards the documents to the credit union for approval. Historically, automobile financing has been perceived as a lower-risk form of lending, with risk spread among a large volume of smaller-balance, collateralized loans. Recent instances of weak indirect automobile lending programs, however pawn shops in Connecticut, have indicated insufficient collateral values and marginal or deficient borrower repayment capacity, resulting in substantial financial consequences for the credit union.
Some evidence suggests that increased competition is negatively influencing indirect automobile lending programs. Heightened competition has prompted credit unions to offer lower interest rates, lengthen amortization periods, and scale down payment requirements. In some cases, competition has prompted credit unions to grant lending authority to the dealer in order to expedite the approval process for loans that fall within credit union-approved guidelines. Credit unions sometimes have extended their risk selection standards to enable them to finance lower credit quality accounts, often referred to as subprime loans. Today’s indirect automobile lending practices represent unique challenges to credit unions and the Department.
Types of Programs
In today’s marketplace, there are generally two types of automobile programs which are being utilized by credit unions. The first and most prevalent is a point of sale (indirect) relationship where the dealership provides loan application documentation, allowing the credit union to underwrite and decision the credit worthiness of the prospective borrower. If the prospective borrower qualifies for membership and an extension of credit, the borrower contracts directly with the dealership for the purchase of the automobile and subsequently the dealer assigns the resulting retail installment contract (indirect loan) to the credit union. Normally an indirect program is evidenced by a contractual relationship between the credit union and the participating dealership. The second program is less formal and is typically referred to as a “dealer referral program”. As part of a referral program, the dealer may send the prospective borrowers directly to the credit union. The credit union may then qualify the borrowers for membership, and underwrite and decision the extension of credit utilizing the credit union’s internal loan standards. Regardless of the type of program, a credit union must be careful not to get lulled into a false sense of responsibility to approve loans. Ineffective underwriting and weak decision-making may result in high delinquencies and potentially larger charge-offs for the credit union. Under either program, if the loan losses become excessive, it can place the safety and soundness of the credit union and its future viability at risk.