Best Practices Make Indirect Lending Successful

July 28, 2005

Indirect lending through automobile, recreational vehicle, and other big-ticket dealerships can be one of the most effective ways for a credit union to build a lucrative loan portfolio. This lending strategy eliminates much of the expense and effort involved in marketing loans and offers a steady stream of business.

But like any other business segment, the success of indirect lending as a core product requires considerable attention to best practices. It requires processes that assist the credit union in managing the asset, the dealer, and the member/borrower.

“Building relationships with the dealers and their finance managers is the key to maintaining a strong and successful indirect lending program,” says Ron Patton, senior vice president of lending for Toledo Area Community Credit Union. “Once a credit union establishes a good rapport with its respective dealers, it needs to establish good relationships with its members.”

Indirect lending can be more risky than direct lending because the credit union never directly interviews the potential borrower. Ultimately, the credit union relies on the dealer to interview the new borrower and provide the necessary information to render loan decisions. Often, the new borrower isn’t a member of the credit union.

The underwriting process also is more sensitive and requires detailed loan monitoring and tracking to include dealer and member performance. Therefore, it’s in the credit union’s best interest to develop and maintain successful business alliances with the dealers.

“Indirect lending programs receive more scrutiny from regulators than direct lending programs,” Patton says. “It’s a riskier loan type, but if an institution has all the correct procedures and practices in place, it will succeed.”

Successfully monitoring and tracking indirect loan performance starts with systems and technology that provide loan tracking, report generation, and collection queuing. Consider the best practices below when managing an indirect lending program.

Loan Identifier

Loans must be easily and accurately identified as indirect. When an indirect loan is created either through the underwriting or booking process, assign it a collateral code that distinctly identifies the loan as indirect. This allows the credit union to generate reports and establish collection queues specific to indirect loans.

New Borrower Contact

Indirect lending provides credit unions the opportunity not only to book new loans but to add new members. As soon as a dealer books an indirect loan, credit unions can connect with that borrower and offer additional services.

Contacting the borrower is invaluable and serves several purposes. Primarily, it’s the first contact a borrower receives and it’s a good opportunity to build the relationship by offering additional services. It’s also a good way to obtain additional information to identify potential problem loans. By conducting a short interview, the credit union can update records and provide information to the new borrower regarding the payment process. Contacting the borrower will minimize the number of first payment defaults.

The most effective way to initiate contact is with a mailing followed by a phone call. The mailing thanks the borrower for his or her business (carefully identifying whether this is a new or current member), provides a first payment reminder, and encourages the member to call with questions. When working with new members, include literature about credit union rules and available services.

Place a follow-up phone call within a week after a mailing. This allows the credit union representative to give a first payment reminder and conduct a borrower interview. It’s critical to maintain current information on the borrower and to address any concerns about the loan early in the process.

“We follow up with new members to determine how their experience at the dealer was handled,” Patton continues. “It’s imperative to follow up and ensure the member understands that the credit union is proactive and concerned about his or her account.”

Collection Queuing

Responding quickly to problem loans is crucial for portfolio stability. The chance of detecting problems early is greater when credit unions implement a collection queuing system designed specifically for indirect loans.

Credit unions are accustomed to managing collections with queuing systems. However, because the risk is greater with indirect loans, the queuing process must be more aggressive. The first payment provides a strong indication of future collections. Therefore, handle first payment defaults without delay. Occasionally, first payment defaults can be the result of misunderstandings of when or where payment is to be made. Rectify these errors quickly and note the details in the loan file.

“Follow up immediately on first payment defaults,” Patton advises. “We want to know there’s an actual person at the other end of the account and have procedures in place to follow up on late payments and move aggressively on first payment defaults.”

Document every borrower contact, especially during a collection call. With periodic reports and complete loan history details, it’s often possible to identify potential loan collection problems. Such notes are called “unstructured data.” They help predict the probability of collection problems.

Predictable loan problems deserve special “preventive” attention in the form of periodic follow-ups to determine if circumstances have changed that might impact collections. Some loans perform but require continuous management. Identifying when a loan won’t perform, regardless of the management effort, is critical.

Protect the Collateral

Despite a credit union’s best efforts, some loans default. Promptly handling defaults is especially necessary with indirect loans. The objective is to protect the collateral. Loans occasionally have common attributes (found in unstructured data) on previous defaults. Identify the primary predictors of loans that won’t perform, such as past due loans in which the borrower is a flight risk or loans that are 60+ days delinquent. Remember that a vehicle is a depreciating asset that loses value on a monthly basis. The sooner you repossess and dispose of the collateral, the smaller the loss.

Product Cancellations

Once the credit union repossesses a vehicle, initiate reimbursement on all added backend products such as warranties, maintenance agreements, credit insurance, and GAP. In most cases, reimbursement is filed with the dealer. Reimbursement can greatly minimize the loss per loan to the credit union. Keep track of cancellation requests to ensure that funds are received and applied to the loan.

Disposition

Disposing of the vehicle in a timely manner directly affects the loss the credit union can incur. Remember, the vehicle continuously loses value as it ages.

The method of disposition will affect the overall loss. Investigate all options for disposition, including auctions, retailing, or third-party administrators. The investigation should take into account the average value obtained from each method, including disposal time.

The prevalence of indirect lending shows the value of this service to the dealer, the credit union, and the member/borrower. When properly administered, tracked, and managed, indirect lending can be a major contributor to stellar credit union performance.

This article first appeared in Credit Union Magazine at www.creditunionmagazine.com and is reprinted with permission. Author Kathy Strawmatt works for Denver-based Aimbridge. Contact her at 303-695-1005.

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