PHILADELPHIA — Seismic shifts in the economy in general-and car sales in particular-are skewing CUs' auto lending portfolios even more towards used car loans, which brings with it some additional risk for credit unions to manage.
As new car sales fall off at a dramatic rate and used auto sales see a bump, CUs need to be ever more aware of the specific risks inherent in that marketplace especially when many dealerships find themselves on the brink.
"What credit unions should be very focused on is educating their members to ensure that if they are buying vehicles from used car dealers, or even franchises, that the dealer has the title to the vehicle the consumer is buying," said Larry Highbloom, CEO of VINtek. "There has been an increased in level in incidences where dealers receive vehicles in trade, they do not pay off an existing lien, they put a vehicle on the lot, and an unsuspecting member walks on the lot, gets a loan from the credit union and the dealer goes bankrupt. [Now] the credit union financing their member has no title and no lien. The member cannot drive the vehicle because they cannot register it and the poor soul who traded in the vehicle is now being shown as delinquent by his lending institution."
It has been an accepted practice for years that the dealer pays off the remainder of the loan to a customers' financial institution when he brings in a vehicle for trade. In those situations the dealership takes possession of the car title and instead of handing over cash for the trade-in, pays the FI. "Floating payoffs" allow dealers to have more cash on hand each month and keeps the enterprises more liquid, but in today's economy allowing a dealer to utilize this practice can leave members and credit unions alike high and dry.
In For A Bad Day
"In the current economic environment, dealers may not have the cash to keep that going and when they collapse whoever is involved is in for a bad day," Highbloom explained. "The risk is now prevalent at all levels because of the very significant downturn in automobile sales at the new car level. A franchise dealership is now relying more on used car sales than ever before, and yet their capital investments are configured for new car sales."
Highbloom stressed the need for "lien perfection," a service his company performs as it handles the processing and storing of both electronic and physical titles for financial institutions, including CU behemoth Navy Federal. While he recommended credit unions outsource this operation to professionals and focus themselves on their "core competencies," Highbloom did strongly advise CUs to retain physical titles, not copies from dealers or private sellers before funding loans and to keep good track of those titles themselves if they chose not to go the third party route.
Keeping a close eye on the accuracy of vehicle history and educating members to get professional vehicle inspections before buying a used car is also critical because of the propensity for fraud in the marketplace.
"We've even seen cases in some markets where franchise dealers have been fooled on having reconstructed vehicles on their lots and they don't even know it. Even they get victimized by unscrupulous folks," said Jack Jordan, VP-Product Management at Teres Solutions.
FICO Scores Likely To Drop
Obviously one of the greatest risks in used auto lending, especially in a recession, comes from the borrowers themselves. With delinquencies and foreclosures soaring, FICO scores are likely to drop nationwide, Jordan pointed out, making credit scores much less reliable.
"A high credit worthy individual that can afford to buy a new car but chooses to buy a used car is generally a savvy borrower...there are significantly higher risks of the type of borrower that purchases in the used car market because he has to," he said. "[And] any time we enter a very volatile period credit scores will be less reliable, which means placing more emphasis on traditional things like job stability."
There are ways credit unions can protect themselves as they venture deeper into the used auto sector. Jordan praised the idea of adding the cost of warranties and GAP insurance to the loan as many members on the low end default when they cannot afford to repair their vehicles; the higher loan costs and added protection preserves both the credit union and the member in these cases.
There are even greater wild cards in the marketplace today than in past recessions as huge manufacturers like General Motors and Chrysler near bankruptcy, Should those car makers fail, the impact on the value of their vehicles is a very big unknown.
"Would that translate to a higher rate of delinquencies?" Highbloom mused. "I don't think anyone has been able to prognosticate on that, but we're certainly worried about it."
CUs can also not afford to simply rely on new cars either to avoid taking risk mitigating action as that segment carries its own dangers.
"New car lending frequently involves a higher-risk in that the size of loan defaults can be substantially larger than on used cars," Jordan noted. "And the depreciation factor in new car lending is often pretty shocking."
