Let’s Be Direct About Indirect Lending

By Katie Kennedy, Internal Audit Supervisor

While through the years indirect lending has proven to be a viable way to increase the loan portfolio for many financial institutions, that growth has not come without a price. Indirect loans are often associated with a higher degree of losses because of default and, sometimes, fraud. There is also that ever-present fear of the unknown. The borrowers frequently are complete strangers to the financial institution, and at the same time the financial institution needs to rely on the dealership to properly identify these borrowers. Scary thought, isn’t it? This risk is further increased by the fact that at the end of the day, the goals of the dealer (to sell as many cars as possible) are not necessarily in line with those of the lender (to have profitable growth in its portfolio). So how do you solve that issue?

The solution—at least on the face of it—is a simple one: control. Lenders have the ultimate power to decide on the relationships they accept. Before entering any relationship with a dealer, the lender should perform a visit to see how the dealer is conducting business, what type of inventory the dealer has, and perform online and business database searches. What kinds of reviews do you see for these dealerships through online searches? Do you find any complaints or grievances from employees or former employees in your search? These things can be a good indicator of whether this is truly the business you want a relationship with. What about financial viability of the dealer, especially if there are any buy-back or recourse provisions. From there, develop clear agreements that outline the responsibilities, compensation structure, due diligence requirements and any recourse provisions as appropriate. Be sure you have an ongoing process in place to monitor these relationships periodically.

The loans you are getting from the dealers should be closely monitored as well. Do you find that certain dealers have higher losses than others? What about quality control omissions or defects? What kind of story is the loan activity telling you? Ideally, you should have staff who are experienced and have the time to carefully review and analyze each loan prior to funding as well as monitor the activity for trends.

At Wipfli, we can help. With experienced staff trained in the nuances of indirect lending, we can review your program and see whether there are areas that could benefit from improvement in not only your loan origination controls, but also in those dealer relationships.