SALT LAKE CITY – Robert Hogan agrees subprime indirect auto lending is "definitely a risky business," but that shouldn't deter credit unions from getting involved in the product area. With the right due diligence, the president of CU Credit Connection says the service can benefit both members and credit unions. CU Credit Connection was organized about a year-and-a-half ago as a subprime indirect lending multi-owned CUSO with Hogan, Robert Coombs, John Arens, John Taggart, Don Poulton, and America First CU as partners. Coombs and Arens previously owned the software lending platform DecisionApp that was sold to CU Direct when that company acquired Indirect Services Inc. in 2004. CU Credit Connection uses the same DecisionApp indirect lending system to receive subprime indirect loans for credit unions, as well as communicate with dealers. It is also starting to get into subprime direct lending for America First CU using MeridianLink's LoansPQ. That's the key that differentiates CU Credit Connection from other subprime auto lenders like Centrix, said Hogan. CU Credit Connection manages its credit union clients' subprime auto loan portfolios and services them through Systems & Services Technologies Inc. (SST), St. Joseph, Mo., which provides CUs with a daily Web-based reconciliation report on their account activity. It also has a relationship with CU Direct as its service provider for the processing of loans. The company uses a five-tier risk based price system for loan determinations, based on the following minimum FICO score: Tier 1 – 640; Tier 2 – 620; Tier 3 – 600; Tier 4 – 580; and Tier 5 – recent bankruptcy. When a credit union rejects an indirect loan application from a dealer because the applicant doesn't meet the CU's credit standards, the application is redirected to CU Credit Connection, which uses DecisionApp to underwrite the loan and fund the contract. Funded contracts are forwarded to SST using the DecisionApp system. CU Credit Connection also uses DecisionApp to communicate declined loans directly to the dealer; loans that are approved are also communicated directly to the dealer using DecisionApp and are accompanied by stipulations required to fund the contract by CU Credit Connection. When a dealer sends its completed loan package to CU Credit Connection for review and audit, the company audits it for completeness and accuracy. Any loan package that CU Credit Connection determines doesn't meet strict funding guidelines based on the information the company receives at the time of the application, is returned to the dealer. Once loan packages pass muster and are determined ready to fund, the application is returned to the CU, which then disburses the funds to the dealer and the necessary fees to CU Credit Connection. The CU owns the funded loan and retains all the interest yield on it. The maximum subprime loan CU Credit Connection makes is $35,000, and the maximum term is 72 months. "There are others in the subprime lending market that will buy deeper than a 580 FICO score. But based on our experience, the 580 is a level of loss that's tolerable for the interest rates we can get. You want there to be enough yield in the interest rate to cover any possible losses," said Hogan, noting that federal credit unions are limited to charging a maximum 18% interest rate on loans. According to Hogan, about 35% of Americans have had problems with their finances at some time in their lives, and over $275 billion in subprime auto loans are generated annually. He estimates about 65% of credit unions' auto loan applications are denied because of credit problems. "Subprime indirect auto lending definitely takes more intensity, underwriting and verification time," said Hogan. "But credit unions are already incurring the costs to review subprime loans that are declined, and those members are being underserved and forced to go somewhere else for their auto financing and pay higher interest rates," said Hogan. He's well aware of all the reasons CUs are cautious about getting into the subprime indirect auto lending market-heavy initial costs, on-going fixed costs, and a lack of specific sub-prime expertise. The underwriting for this market differs from prime lending and it can be expensive with lower look-to-book ratios, he said. In addition, collections are very hands-on and labor intensive with expensive system requirements, and it's difficult to achieve economies of scale without being a major subprime player. Even so, Hogan is certain this is a market credit unions can safely serve. Marcia Coombe, vice president of call center for Riverdale, Utah-based America First CU, a CU Credit Connection client, admits when it came to the $3 billion CU deciding whether to get into indirect subprime auto lending, "We were worried about the risk. But we also knew going into it that we had to do our due diligence and make sure we were monitoring the sub-prime underwriting and servicing. We feel in the year-and-a-half we've been doing sub-prime auto lending that we've done a very good job on that." As of the end of May, America First's total auto loan portfolio was $1.2 billion, and of that $22.5 million were subprime indirect loans. Coombe estimates about 15-20% of the indirect loan applications that come into America First through its indirect lending partner CU Direct, are denied and forwarded to CU Credit Connection for review. "CU Credit Connection is very conservative and makes sure we're being competitive in the market without being too risky," she said. Coombe advises any credit union considering getting involved in indirect subprime auto lending and working with a vendor to make sure they do their due diligence on the company to make sure they have good underwriting guidelines. As for her thoughts on NCUA's subprime indirect lending risk alert the agency issued last year, Coombe said, "The risk alert was good for credit unions because it helped us realize you can't just take on a third-party vendor and not know what they're doing and that you need to keep an eye on them." [email protected]