Striking the right balance between growth and risk

The buzz around the industry has all eyes on collateral values, which are expected to continue to decrease into 2018. Questions remain:  How long will this trend continue?  What percentage of consumers that own a car will now have negative equity and will this negative equity position lead to more credit defaults?  What can credit unions do to protect themselves? As we know, the appraised value of an asset being used as collateral today, may not hold the same value over the course of the loan. While we hope adjustments and decreases do not affect values dramatically, there are checks and balances that can be put in place to mitigate the impact on your auto loan portfolio.

Some things to think about:

1. Diversification of the Portfolio—If certain vehicles are coming back with negative equity positions, a review of the portfolio should guide your action plan. Is there a concentration of those vehicles and are you prepared to handle any fallout? One way to remedy this is by setting aside enough funds to address falling values. It may be time to stop lending on certain vehicles until conditions stabilize.
2. Review Advance Guidelines—With some advances going over 125%, credit unions may not want to allow a borrower, with a lower credit score, the ability to obtain a loan with advances as a high as a Super-Prime borrower.  
3. Periodic Review of Auto Loan Portfolio—During the lifecycle of the loan, analysis of the portfolio should be conducted on a regular basis to manage outcomes. This allows the credit union to reserve more for anticipated losses while making underwriting adjustments.
4. Lending to Riskier Borrowers—This is the time you may want to review credit tiers to see how each is performing.  Make adjustments as needed and be willing to walk away from riskier borrowers.
5. Impact of Negative Equity—Similar to what took place in the mortgage industry, homeowners walked away from their homes.  The same case can be made for auto loans that are upside down. Members who do not have skin in the game may very easily default on their loans. This is a good time to work hand in hand with your collection department to ensure that they are able to work with members who may be having difficulty.

In addition to reviewing your conventional auto loan portfolio, credit unions who participate in leasing, should do a comprehensive review of their leasing portfolio as well. If your credit union participates in leasing, it is critical to make sure the tools used for projecting values are the best in the industry.

Key questions for review:

1. Does the credit union or the vendor take all the risk for the residual value?
2. What methodology does your vendor use when coming up with residual values?
3. Has the vendor demonstrated longevity in the leasing market?
4. Have you had a good financial experience with your leasing partner?

While you may have done everything to ensure your portfolios are not impacted negatively, periodic review of your current processes, underwriting guidelines, and collections department procedures will benefit you greatly. How aggressive do you want to be in this market, and can you afford to be? Like all business trends, we are in a cycle. It may be time to pull back in some areas, but not so far that you are unable to do any lending.  There are many opportunities to capitalize on, but it must be done while striking a balance between protecting the credit union and managing growth.