Monday, April 24, 2017

Indirect Used Car Lending Contributed to the Failure of Valley State Credit Union

It appears that a rapid growth in indirect used car lending played a significant role in the failure of Valley State Credit Union (Saginaw, MI).

Valley State Credit Union failed on March 31, 2017.

The following graphs provide a visual depiction of rapid growth in used car and indirect lending, the growth in delinquencies in used car and indirect loans, and the subsequent spike in net charge-offs in used car and indirect loans.

Between September 2014 and December 2015, used car loans rapidly expanded by almost 236 percent from $2.3 million to almost $7.86 million.

Over the same time period, indirect lending expanded from 11.08 percent of total loans to peaking at 33.89 percent of all loans.

Used car loan delinquency rate went from 3.02 percent in September 2014 to 30.68 percent as of September 2016.

Indirect loan delinquency rates went from 4.84 percent to 33.35 percent over the same period.

In the fourth quarter of 2016, net charge-offs for used car loans and indirect loans were $1.4 million and $1 million, respectively.


  1. Hi Dr. Leggett.

    You've posted graphs but have not added any context. What was Valley State's credit quality like? What was their dealer mix? Deep subprime with independent used auto dealers could certainly have results like this, but it is in no-way indicative of the used car industry as a whole, as all 3 credit bureaus point out to us in quarterly studies.

    1. Unfortunately, Call Report data does not provide a credit profile of borrowers or dealer mix. Unless NCUA's Office of Inspector General does a Material Loss Review, we will not know the answer to those questions. However, it appears the loss to the NCUSIF arising from the failure will not reach the dollar threshold mandating a Material Loss Review.

  2. This is a classic desperation move for earnings. In Q2 2014 the used auto portfolio sat at about $1.7m -- exactly where it had been for the prior 6 quarters. During that same time frame, the credit union made a profit in only 2 of the 6 preceding quarters. Its efficiency ratio (profit before PLL expense) averaged 96%, so it was barely generating enough income to cover its most basic operating costs.

    As Dr. Leggett pointed out, used car loans spiked 450% to $7.8m by Q4 2015. During that same time frame, the overall loan yield of the credit union DROPPED 30 bps, so they were not being compensated for the risk they were taking in loan yield.

    Also, during the period from Q2 2014 to Q2 2015 (first year of ramping up used auto loans) the loan loss reserve averaged only 0.34% of loans. So historic modeling of loan loss reserve failed to alert the credit union of the need to greater reserve requirements, which may have slowed down the rate of used auto growth in future periods. Here is a case where CECL (current expected credit loss) modeling would have been useful.

    Regardless, the credit union made an attempt to drive up earnings, by looking to make quick and easy money. It even had to rely upon borrowings/brokered deposits to fund the loans, which is a leverage strategy that failed because they were not being compensated for the additional risk they were taking.

  3. Dr. Leggett, as someone who monitors credit union portfolios on a regular basis and on a level deeper than the call report, allow me to make an observation. Your analysis starts with a credit union indirect delinquency rate of almost 5% that rose to 33.34% and a Used Car Delinquency rate that rose from 3% to 30%. Let me just say, the beginning delinquency rates are proof that this credit union wasn't a very good lender in the first place. Their desperate attempt to increase their portfolio size only exacerbated the issue. Indirect lending is not bad, bad indirect lending is bad. I would suspect that this credit union had zero portfolio management strategies in place, rarely analyzed portfolio risk, and most likely booked a lot of subprime auto loan paper in order to drive growth and lower delinquency ratios over the short run. As the previous commentator mentions, they made no allowance in reserves for the additional risk. In the end, while a poorly managed Indirect strategy may have expedited this credit unions failure, their status before "ramping up", is indication enough that their portfolio management overall is the significant factor for its ultimate failure.

    1. Michael, you make excellent points.



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