Over the last several years, credit unions have increased their lending for both new and used automobiles. In 2016 alone, auto lending at federally insured credit unions increased $36.7 billion, or 14.0 percent. Used auto loans rose $19.9 billion, or 12.3 percent, to $181.8 billion. New auto loans rose $16.8 billion, or 16.8 percent, to $116.9 billion in 2016.
A key aspect of this growth has been indirect auto lending. An indirect lending relationship exists when members who meet the credit union’s field-of-membership requirements apply for credit directly through a car dealer. By the end of 2016, there were $165.1 billion in indirect loans outstanding, up from $136.6 billion in 2015, a nearly 21 percent annual increase. Indirect loans account for 19.0 percent of total loans at federally insured credit unions.
Growth in Credit Union Indirect Lending 2015–2016
|Loan||Year-End 2016||Year-End 2015||Change in Dollars||Change in Percent|
|Reportable Indirect Loans Delinquency||$1,261,792,705||$987,408,444||$274,384,261||27.8%|
|Non-Reportable Indirect Loans Delinquency (30–59 days)||$2,516,661,594||$2,109,085,376||$407,576,218||19.3%|
|Indirect Loans Net Charge-Offs||$994,815,813||$781,877,867||$212,937,946||27.2%|
If done properly, indirect lending allows credit unions to offer a convenient method for their members to obtain the financing necessary to purchase a vehicle and to diversify their loan portfolios. However, an indirect lending program does have risks associated with it. As a result, a credit union should establish clear expectations and have regular contact with participating dealers to ensure the program is being administered in accordance with the board of director’s expectations for risk management.
With all of these considerations in play, credit unions need to be strategic when managing an indirect lending program. This means:
- Establishing appropriate growth goals and concentration limits, along with minimum standards for creditworthiness, such as credit score and debt-to-income requirements. Credit unions should only change these limitations or requirements after their portfolios have seasoned and their boards have confidence that the systems and processes in place are effective.
- Implementing processes to keep the board of directors informed of the performance and risk-levels of the portfolio;
- Monitoring the portfolio, such as performing a multi-dimensional portfolio analysis and static-pool analysis, to ensure it’s meeting the board’s risk-tolerance levels;
- Setting loan rates to ensure adequate profitability—the lower the credit quality, the higher the price for the increased risk of potential losses;
- Establishing a comprehensive portfolio-management system. This requires more due diligence than simply looking at credit scores to assess and manage risk. For example credit unions should consider:
- Does your portfolio include a concentration of loans with loan-to-value ratios greater than 100 percent, lengthy terms or low interest rates?
- Do you understand how the portfolio is changing over time?
- Does your policy clearly define the formula used to determine a vehicle’s value?
- Taking early action to revise the program when adverse performance trends occur.
Additionally, credit unions should manage their lender relationships by:
- Ensuring your credit union has experienced staff who can manage an indirect lending program in a safe and sound manner;
- Establishing well-defined lending criteria and quality‑control programs for each dealer. Credit unions should regularly evaluate the performance of the loan portfolio generated from each dealer;
- Limiting the amount of interest a dealer can up-charge your members;
- Managing your incentive structure effectively to ensure dealers and staff are focused on loan quality, not just loan volume;
- Managing your servicer relationships effectively, especially for purchased participations and loan pools;
- Conducting internal audit reviews regularly; and
- Reporting the portfolio’s performance and quality, such as statistics on approvals and denials, and overrides of your policy guidelines to the board of directors on a regular basis.
Credit unions offering indirect lending should understand the unique risks associated with this type of lending and have the expertise and processes in place to offer this service safely. This includes staying on top of trends in the auto lending market, which are currently showing signs of increased credit risk, and regularly evaluating the effectiveness of a credit union’s risk-management practices.