CU Jury says NCUA's Concern with Subprime Indirect Lending Valid, "Nothing Sinister"

WEST PALM BEACH, Fla. – Credit unions have had four weeks to digest Risk Alert No. 05-RISK-01 that NCUA issued last month concerning “Specialized Lending Activities – Third-Party Subprime Indirect Lending and Participations” – and while the agency chose to use strong language, even describing stiff penalties for lack of compliance, credit unions involved in indirect lending that Credit Union Times spoke with say NCUA’s concern is, as one put it, “absolutely valid.” “NCUA has every right to be concerned about credit unions’ use of third party vendors to do subprime indirect loans. If this type of indirect lending is not done correctly, it can be very harmful to credit unions,” says Greg Blount, president/CEO, Tropical Financial CU. TFCU is one of four owners of South Florida Acceptance Corp., a multiple-owned CUSO formed in 2003 and owned by the founding four south Florida-based credit unions to do indirect lending. The other three CU owners are Power 1 CU, City County CU of Fort Lauderdale and Pan-Am Horizons FCU. Blount explained that when the CUSO was formed, the owners agreed that it would focus primarily on A, A-plus and B paper. “While it was necessary to look at other paper, we determined early on to make sure the dealers understood our loans would not exceed 5% C and D paper. In the course of events there can be difficulty in indirect lending itself, and because we were relatively new to the marketplace we decided this was the best policy,” he says. SFAC currently has relationships with almost 70 dealers in the tri-county area that includes Palm Beach, Broward and Dade counties. In its best months it has brought in about $12 million in indirect loans, and at its lowest it’s done $6-$7 million. “We’ve seen several credit unions suffer badly as a result of depending on less than reputable third parties to provide them with subprime loans. Whenever you go outside your organization, you have to have a strict set of controls established to make sure the credit union remains in control and knows what’s going on,” says Blount. That’s a point everyone Credit Union Times talked with on the issue reiterated. “Anyone involved with indirect lending knows you have to do it right,” says John Dolan-Heitlinger, president/CEO, Keys FCU. “It’s part of credit unions’ mission to help people who have been through tough times, but it’s different and more of a challenge. If you’re lending to people who are already showing credit problems, you have to do very careful underwriting. Still that doesn’t mean you shouldn’t talk with these people.” Commenting on NCUA’s Risk Alert Letter, Dolan-Heitlinger says, “If what the NCUA is saying is if you do subprime indirect lending through third-party vendors then you need to have certain reporting practices and expertise on staff in place, then that’s sort of what they did with member business lending, and that’s fine. It’s reasonable for the regulator to say and a legitimate thing NCUA should be concerned with, so long as they don’t say it’s a bad thing.” Keys FCU has been doing indirect lending on its own for about seven years and has relations with all of the new and used car dealers in Monroe County which includes the Florida Keys. Dolan-Heitlinger says the credit union has a 40% market share of all car loans in Monroe County, a larger share than even the captives financing loans there. Keys FCU has $60 million in its auto loan portfolio, and 70-80% of that comes from indirect loans. The credit union recently signed on to SFAC to be able to expand its access to dealerships on the “mainland” of Florida. “Most people think of the Florida Keys as being a tourist area, but Monroe County is actually a small rural county,” says the Keys FCU president. “Sometimes Keys FCU members interested in buying a Volvo, Saab or Mercedes drive there for those dealerships since there aren’t any down here.” Keys FCU makes subprime indirect loans to members, but it doesn’t use a third-party vendor. Instead it relies on the expertise of its staff and collections methods. “A credit union should be able to underwrite any kind of paper, but you have to understand how to underwrite it and make collections. If the borrower is a couple of days late, you better call them about their payment. If a credit union has never done subprime indirect lending I suggest they get significant training before stepping into it,” says Dolan-Heitlinger. Community Educators CU also manages its own indirect lending service, and President/CEO David Brock says the $199.8 million CU tries to extend credit union to all of its nearly 30,000 members by finding ways to condition loans to mitigate the risks. “If a member’s credit score is lower than B paper then we’re more conscientious about trying to condition the loan to an acceptable level of risk,” Brock explains, such as requiring the member make a larger down payment or encourage payroll deduction. “We consider that a reasonable risk management tactic,” he says. Even so, despite its best efforts to make an indirect auto loan work for a member, there comes a point where Community Educators sometimes has to say `no’. “There’s a limit to how far we can go in the process, we’re not a charity. If we think it’s beyond our risk process then we won’t do it,” he says. Brock says Community Educators CU approves about 60% of the indirect loan applications it receives. Indirect lending accounts for about 15% of its total loan portfolio which at the end of May was $203,244,194. Community Educators has about 36 dealerships in its indirect lending network. As for NCUA’s Risk Alert letter, Brock says he assumes “they’re trying to get a clear picture of what kind of activity is taking place. They’re just trying to do a reasonable analysis.” -