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Loan Management and Collection Practices

Managing the Basic Components of Indirect Lending is Critical

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, on-going loan portfolio. This lending strategy eliminates much of the expense and effort involved in marketing loans and offers a steady stream of business. Nationwide, the credit union industry has embraced indirect lending to the extent that indirect vehicle loans represent a large portion of credit unions’ consumer portfolios.

But like any other segment of business, the success of indirect lending as a core product offering 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 a relationship with the dealers and the Finance Manager at the dealership is the key to maintaining a strong and successful indirect lending program” said Ron Patton, senior vice president of Lending for Toledo Area Credit Union. “Once a credit union establishes a good rapport with its respective dealers, it needs to focus on establishing 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 a loan decision. Often, the new borrower is not a member of the credit union. The underwriting process is also more sensitive and requires detailed monitoring and tracking of the loans to include dealer and member performance; therefore, it is in the best interest of the credit union to develop and maintain successful business alliances with the dealers.

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

The key to monitoring and tracking indirect performance starts with systems and technology that provide loan tracking, report generation and collection queuing. The most successful programs will allow credit unions to execute best practices required in managing a successful indirect lending program. Several best practices should be considered when managing an indirect lending program.

Loan Identifier

The first practice is to ensure the loan is easily and accurately identified as an indirect loan. When an indirect loan is created either through the underwriting or booking process, the loan should be assigned a collateral code that distinctly identifies the loan as indirect, allowing the credit union to generate reports and establish collection queues specific to indirect loans.

New Borrower Contact

Indirect lending provides credit unions the opportunity to not only book new loans, but in some cases add new members. As soon as a dealer books an indirect loan, credit unions have an ideal time frame to connect with that borrower and offer additional member services.

Another best practice is borrower contact. Contacting the borrower is invaluable and serves several purposes. Primarily, it is the first contact a customer receives and it provides a good opportunity to offer member service, thereby building the relationship. It is also a good way to obtain additional information to identify problem loans. By conducting a short interview, the credit union can update records and provide information to the new borrower regarding the payment process. Taking time to contact the borrower will minimize the number of first payment defaults.

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

After a mailing, always place a phone call within one week. This provides the credit union representative the opportunity to give a first payment reminder as well as a customer interview. It is critical to maintain current information on the borrower and to address any concerns about the loan early in the process.

“We have a marketing plan in place to follow up with new members,” Patton continued. “Our courtesy phone calls are used to determine how the member’s experience at the dealer was handled. It is 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 and is a practice that credit unions should implement. 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 a queuing system. However, because the risk is greater with indirect loans, the queuing process must be more aggressive. The first payment provides strong indication of future collections; therefore, first payment defaults should be handled without delay. Occasionally, first payment defaults can be the result of misunderstandings of when or where payment is to be made. These errors should be rectified quickly and details should be noted in the file.

“Credit union executives should immediately follow up on first payment defaults,” Patton said. “We want to know that there is an actual person at the other end of the account and have procedures set in place to follow up on late payments and move aggressively on first payment defaults.”

Thorough documentation of every customer contact is necessary and imperative, especially during a collection call. With periodic reports and complete loan history details, it is often possible to identify potential loan collection problems. Such notes are called unstructured data and 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. There are some loans that perform but require continuous management. Identifying when a loan will not perform, regardless of the management effort, is extremely critical.

Protecting the Collateral

Despite a credit union’s best efforts, some loans go into default. When this happens, it is good practice to promptly handle every default situation, but it is especially necessary with indirect loans. The objective is to protect the collateral. Occasionally, loans will have common attributes (found in unstructured data) on previous defaults. It is important to identify the primary predictors of loans that will not perform, such as past due loans in which the borrower is a flight risk or loans which are 60+ days delinquent. Remember that a vehicle is a depreciating asset that loses value on a monthly basis. The sooner collateral is repossessed and disposed of, the smaller the loss.

Product Cancellations

Once a vehicle is repossessed, it is important to 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. Keeping track of the cancellation requests is essential to ensure that funds are received and applied to the loan.

Disposition

Handling the disposition of the vehicle in a timely manner from the time of repossession directly affects the overall loss the credit union can incur. Remember, the vehicle continually loses value as it ages.

The method chosen for disposition will have an effect on overall loss. Credit unions should investigate all options for disposition. Auctions, retailing or third party administrators are all possibilities. The investigation should take into account the average value obtained from each method, including disposal time.

The prevalence of credit union indirect lending is strong evidence of the value this service is to all three parties involved: 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.

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