Without the proper equipment, a rock climber's chances of tumbling off the side of a cliff increase. Likewise, the current economic climate is pushing some lenders and financial institutions to the edge of the metaphorical cliff. Credit unions are at a crux: manage their risk wisely with solid, sound practices to best serve members or suffer the consequences with increased repossessions.

An area of particular focus among lenders is automobile loans. Even though gas prices have dropped recently, rapid devaluation of low-mileage vehicles continues and record rates of negative equity for new-car buyers have contributed to a sense of crisis that's palpable.

Taking a look at our economic environment is a little disconcerting, to say the least. Due to sagging consumer confidence and retail production curbs, a domino effect has spread into job layoffs, which puts pressure on homeowners. With nearly one in six homeowners under water on their mortgages, according to WSJ.com/Moody's Economy.com, it's no surprise to learn that auto loan delinquency is on the rise. As a matter of fact, we've found a 50% increase between the end of March 2007 to end of June 2008 in the amount of all delinquent credit union loans, from mortgages to vehicle loans and everything in between.

When times get tough, the tough get tougher: some of the lenient credit standards we've witnessed in the past are no longer being employed. According to the Federal Reserve Board's “July 2008 Senior Loan Officer Opinion Survey on Bank Lending Practices,” consumer lending standards have tightened. Nearly 65% of domestic banks–up 45% from its April survey–reported tighter lending standards on consumer loans (other than credit cards).

According to USA Today, lenders are pulling back in big ways, like larger down payments being required. GMAC Financial Services is pulling back from financing extras like accessories, sales taxes, extended warranties or remaining debt on trade-in values. Toyota Financial Services has taken a similar approach by no longer going to 110% loan-to-value. Chase Auto Finance is also cutting back high loan-to-value deals saying, “The concern on some of these deals is making sure it's affordable for the consumer.”

There is good news for credit unions in all of this. Member-owned institutions have always had loyalty on their side, and with the decrease in consumer confidence, there is most likely an increase in individuals flocking to credit union lenders to seek the voice of reason. When it comes to automobile loans, it only takes a quick glance at the media to learn American homeowners aren't much different, and most likely the very same people, than car owners: 40% of new car buyers are upside down on their vehicle loan with an average negative equity of $2,200. This negative equity has doubled among average vehicle buyers since 2000, according to USAToday.com, Edmunds.com, and J.D. Power and Associates. So how can credit unions help?

To serve their members in a tough economic environment, lenders must revert to some basic, prudent underwriting practices with which they are familiar. It all starts with the “3 C's” of underwriting: collateral, capacity and character. All are well-known, but they're worth reexamining in light of recent conditions:

Collateral: This is the underlying value of whatever it is your member is seeking to purchase. When it comes to today's car market, it's pretty obvious vehicles are not holding their value the way they used to. In fact, the fastest depreciating types are ones that historically held their weight: SUVs, crossovers, trucks and vans.

This brings up the issue of loan-to-value ratio. As prices of these vehicles are going down, dealers are working extra hard to pack every extra bit they can into a loan. If your loan-seeking member wants to buy an SUV that has automatic everything, an after-market stereo and more, the loan-to-value becomes artificially high. Some credit unions have gone up in their permissible loan-to-value percentages, but 125% or 150% is not a good practice in this economy.

Overall, look at the trends in underlying collateral, and then reevaluate the loan-to-value based on what the value of the collateral will be going forward. Remember, you may have to resell this collateral if it is repossessed.

Capacity: The ability to repay a loan depends significantly on whether or not a person has or will still have a job in the future. All lending is local, and it's critical for credit unions to stay abreast of the local economic climate. This means you need to do your own competitive intelligence. Simply because a company is in your community and is doing well doesn't mean the ultimate parent owner is. Likely, if the parent company is ailing, the child may become ill soon also.

If you are already experiencing layoffs or company closings, it's not a good time to do a lot of lending. But that's not to say it's feasible for volume to drop off–it's about managing good risk. It's about not allowing members to get into risky loans. and this is where character comes into play.

Character: A credit score can be a fair indicator of one's character, but it shouldn't be utilized solely as basis for a loan, tempting as that factor might be. While now is definitely the time to pull in the horns and tighten up credit standards, it seems as though credit unions have gone away, in some degree, from their unique experiences with individual members.

Take a look at your history with that particular member who is seeking an auto loan. You may find his or her credit score is not so high, but you've always been paid back on time. Examining character on a deeper level should be a greater part of the loan-making decision rather than strictly relying on numbers.

Traditionally, one or two of the “3 Cs” might be looked at in a loan evaluation, but it's time to put these essential factors back to work. As in any area of life, there must be a balance, and allowing for equilibrium of collateral, capacity and character mitigates risk while ultimately building member loyalty. If you're not putting a member into a situation you truly think they can't handle, you'll be rewarded in the future.

It's about trust. It's about better serving your members. And, in our current economy, it's about getting back to basics.

Bill Jolicoeur is a vice president of payment protection products at CUNA Mutual Group. He can be reached at 800-356-2644 x7930 or [email protected]