Six Steps to Successful Vendor Selection

There is no such thing as a perfect choice when it comes to partnering with a third-party vendor, according to Daniel Loritz, Esq., managing partner, Okun Loritz LLP, a Glendale, California-based law firm that represents financial institutions. Loritz suggests credit unions take six steps to ensure their final selection is the best one possible for their organization.

1. Do due diligence. After the credit union’s initial risk assessment and planning is complete—which should determine whether the contracting vendor poses a low, moderate or high risk— leaders should conduct due diligence on prospective vendors’ financial heath, general background and business model, Loritz says. 

2. Do a background check. Your credit union should consider a third party’s experience providing the proposed service or program. A well-respected third party may have little or no experience implementing and supporting a new service offering, Loritz points out. In these cases, the qualifications, competence and training of key individuals within the third party’s organization become even more important to verify. 

It is also important to understand how a third party has performed in other relationships, he adds. Credit unions can request referrals from the prospective third party’s clients and evaluate them. Also review and consider any lawsuits or legal proceedings involving the third party or its principals.

Additionally, ensure that third parties or their agents have any required licenses or certifications and that they remain current for the duration of the arrangement, Loritz suggests. Sources of information such as the Better Business Bureau, Federal Trade Commission, credit reporting agencies, state consumer affairs offices or state attorney general offices may also offer useful insights.

3. Evaluate the vendor’s business model. New business models often emerge due to changes in the regulatory, technological or economic environment, Loritz notes. Likewise, longstanding business models that cannot easily adapt may not be sustainable in times of rapid change.

Management should also understand the third party’s sources of income and expense, considering any conflicts of interest that may exist between the third party and the credit union. For example, if a third party’s revenue stream is tied to the volume of loan originations rather than loan quality, its financial interest in underwriting as many loans as possible may conflict with the credit union’s interest in originating only quality loans. Also consider subcontractors.
 
4. Consider the vendor’s cash flow situation. Perhaps one of the most important considerations when analyzing a potential third-party relationship is how cash flows among all parties. Management should be able to explain if and how incoming and outgoing cash flows move between the member, the third party and the credit union. Examiners will ensure that the credit union is tracking and identifying cash flows accurately, Loritz notes.

5. Review the vendor’s finances and operations. Your credit union should carefully review the financial condition of third parties and their closely related affiliates. These point to whether the vendor can deliver on the proposed contract, Loritz says. Consider the financial statements regarding outstanding commitments, capital strength, liquidity, operating results and any potential off-balance sheet liabilities. 

Audited and segmented financial statements or ratings from nationally recognized statistical rating organizations, such as Moody’s, may be useful in periodically evaluating the overall financial health of a prospective or existing third party. If available, use copies of SSAE-18 reports prepared by an independent auditor, audit results or regulatory reports to evaluate the adequacy of the proposed vendor’s internal controls. If these are not available, consider whether to require an independent review of the proposed vendor’s internal controls. Generally, your vendor contracts should include provisions permitting periodic audits or access to third-party records, he says.

6. Review the legalities of the contract. Contracts outlining third-party arrangements are often complex. The National Credit Union Administration (ncua.gov) recommends that credit unions ensure careful review and understanding of the contract and relevant legal issues and suggests it may be prudent to ask qualified legal counsel to review any documents.

“Over the past several years, we have encouraged our clients to request vendor contracts early in the request-for-proposal stage so that the vendor contract (and its strengths and weaknesses) can be evaluated as part of the process of selecting which vendor will be awarded the business,” Loritz says. “By requesting the contract up front, your attorneys can identify which contract is most protective, contains favorable service-level requirements, and contains appropriate term and price increase limitations, among other things. 

“This can all be used as leverage against vendors and may give you the upper hand in subsequent contract negotiations. If you wait until a ‘handshake deal’ has been done and treat analysis of the vendor contract as the final step and only a necessary evil, you are missing an opportunity to use vendor contracts as an important evaluation tool and as leverage with other vendors who are selected for final consideration.”cues icon

Formerly a member of the CUES marketing staff, Felicia Hudson Hannafan is a writer based in Chicago.