The Lure of Indirect
We all know the story. After the major indirect lending banks retreated from indirect, credit unions swooped in to fill the gap. But why did the banks let indirect go? Low margins and, at the time, higher than average delinquency rates.
So why would credit unions go all-in on something the big banks couldn’t make profitable? A few reasons:
- Fresh off the “high” of reaching 100 million members in the US, credit unions saw an opportunity to use indirect as a path towards credit-worthy member growth.
- Indirect lending is “easy”. You need fewer resources to attract & secure the loan. Also, at the time, 2 out of 3 consumers were closing loans at the dealer.
- With interest rates trending upward (after historic lows), credit unions would be realizing higher margins.
Drinking the Kool-Aid
5 years later: What’s the verdict?
Credit unions substantially increased their auto lending presence, going from roughly 17% to 32% of all auto financing. What an accomplishment!
Millions of indirect borrowers became members. According to NCUA, by the end of Q1 2019, membership totalled over 117 million. This was the largest membership increase ever seen in such a short period of time.
With almost all credit unions of size “drinking the indirect kool-aid’, loan volumes increased by over 100% (since the indirect “gold rush”). Credit union total car loans grew 5.3% in the 12 months ending June 30, 2019. Their share of all auto loans was 32.1%, up 0.4% from a year earlier.
But those numbers really don’t paint the picture of incredible growth. How’s this: In 2014, credit union auto loan volume was $183.2 billion. In June 2019, it was $376.6 billion.
In 5 years, the industry went from financing $183.2B to $376.6B.
So, success…right? Wait, how are delinquencies?
Delinquencies have leveled off. NCUA reports the average delinquency rate in Q1 2019 as 66 basis points. That’s not bad.
Ok, delinquencies are good. Loan volume is up. Way up. So, did credit unions make money? Well, that’s where the story starts to take a turn.
Is More Always Better?
Increasingly, we now read about credit unions putting the brakes on their indirect lending, and several major players backed away completely.
Even though gross volume is strong, the same factors (thin margins, high dealer reserves, and even lower interest rates) which convinced the banks to back away remain. Plus, there’s the historical challenge of engaging those new members to take on more than just one auto loan.
According to CUNA, on average, 95% of these indirect borrowers never become active members.
It also hurts credit union’s ability to be “people helping people”. With indirect, credit unions typically cede the opportunity to sell protection products, such as payment protection, GAP, and vehicle service contracts to the dealer.
This not only eliminates a non-interest income opportunity but also, in our opinion, breaches the basic credit union mission. Dealer products are higher cost, and this cost burden is borne by the new member.
So what are credit unions actually netting on their portfolios? Here’s a case study of *ahem* CU (name withheld due to confidentiality) after analysis by the CU Doctor Consultancy firm:
- CU Asset Size: $150 million
- Indirect portfolio: $50 million
- Delinquency: 1.50%
- Charge-backs: 2.00%
- Net Yield after delinquency, charge-backs, upfront dealer fees, program fees: 30 Basis Points
Note: The indirect program resulted in negative spreads and operating losses which eroded net worth from 11% to 7% over a 4 year period.
Yes, this credit union lent themselves into a loss.
Look At Your Indirect
The above case study is specific to one credit union. What’s true for them may not be for your institution. However, it’s important to replicate their analysis and figure out if indirect lending is profitable.
Too bad there’s no way to issue auto loans while building relationships, being true to the CU mission (in our opinion), and producing a profit. Wait a second…that’s direct!
We’ve got 7 steps to help you increase your share of direct auto loans. And help your members. And sell more ancillary products. And…well, you get the picture. Continue reading to the steps below.
Fuel Your Direct Loan Strategy
1. Car Buying Service
Does your institution have a Car Buying Service? If not, get one. If yes, start leveraging it.
Why? According to Google, 95% of consumers start their car buying (and financing) journey online. That’s where your presence needs to be. If your online presence doesn’t include a well-positioned car buying service, you’re simply losing loans to the web.
You can learn more about choosing one or making yours excel on our Learning Library. Already set with your car buying service? Great! You’ll want:
Ensure your Car Buying Service is running at full power and increase conversions by up to 200% with our 5 Step Cheat Sheet!
Let's Do It!
2. Relationship Rewards
Indirect lending is short term thinking. Start thinking long term. Whether the member is celebrating 20 years of loyalty or their first month, create a path that encourages them to utilize more of your services. Be creative.
Incentivize membership. Ensure your products and services provide enormous value.
Think outside the loan. Institutions that provide programs such as Rewards and Value-Added Checking enjoy more services per member. This helps build direct loan volume while differentiating your credit union from all the Fintechs trying to steal members away.
3. In-Branch Staff Awareness
How much potential business just walks through your branches…every day? There’s substantial business, auto loans included, if your staff knows how to ask the right questions. This applies to refi’s as well.
Today, if a member comes into your branch, consider them loyal. Ensure they feel welcome and assume (the good kind) that there are ways you can help. Learn how to uncover needs and opportunities with our 4 Conversational Tips Sales Cues Cheat Sheet.
4. Online Presence
6 Seconds. That’s all the time you can expect people will spend searching on any given page (unless they’re reading some awesome content on a way-cool Learning Library). After that, there are two things a visitor can do:
- They find and follow a link that resolves their reason for visiting.
- They get distracted or frustrated and abandon the page.
More members visit your website than your branches. So ensure it behaves like a friendly branch with these tips:
- If you have a car buying service, make it prominent and easy to reach. Why? 80% of consumers in-market for a car start their car buying journey researching and shopping for a car, not a loan.
- Make the answers commonly asked prominent and easy to find.
- Where possible, minimize the use of “fine print”. If you must use the language, place it upfront for full transparency and to build trust.
- Remove interstitials (speed bumps) or make them more “friendly”. Google studies show a marked increase in abandonments on pages with interstitials. We wrote about the challenges interstitials pose for your institution.
- More than half your members use a mobile device to connect with your institution. Therefore, your website must be fully responsive and functional on all screen sizes. Plus, your mobile app should be the easiest and fastest way to interact with your institution.
5. Loan Application
The days of “complete this form and we’ll get back to you” are over. Borrowers expect an instant (or near instant) decision. Modern LOS (and cores) can easily accomplish this. Your institution’s responsibility continues:
Reach out to the borrower to set expectations about the process. Share their rate, term, and payment information, and also:
- Provide a brief description (and links) for your Protection Products (videos are even better…discussed below)
- Link to your Car Buying Service
- Describe how the loan document e-signing will work
- Explain the need for the dealer to forward the purchase order
- Provide options on a share draft or direct dealer payment
6. Incentives & Discounts
How much does an indirect loan cost your institution? There’s the dealer reserve of 1%, 2%, or more. Factor in the cost of risk and actual cost of funds. Then, include the cost of not adding ancillary products to the mix.
As a community-focused institution, think of how you can save your borrowers money. Consider a flat percentage or dollar amount as an incentive (if they also use other services). You still save compared to indirect, while putting dollars back into your borrowers’ pockets.
Additional discounts may be available through a rewards relationship plan or even subsidized by a car buying service.
7. Digital Sales Strategy
Ancillary products protect borrowers while generating non-interest income. Everyone wins. Training staff to sell is great, but what about the growing number of borrowers who prefer a fully digital experience?
Introduce your protection options early in the process. That way, a borrower isn’t seeing them for the first time as they book the loan. If they do, you know what happens…”no thanks”.
Help your borrowers understand and research these products to decide if they make sense for them. The challenge: There’s a lot of bad information out there.
Check for yourself. Though the majority of articles are in favor of GAP, most are against vehicle service contracts and payment protection. Unfortunately, most are quite subjective (some erroneous), and do not consider the specific needs of the borrower.
It’s your responsibility to provide honest, unbiased information that empowers the borrower to learn on their own time. 30 to 60-second videos on your website are a great way to pique your member’s interest.
Reference them upon getting approved so they can determine if they’re a fit early on. Then, set the expectation of chatting with a staff member. The purpose will be to review their options and ensure they fully understand all aspects, including payments.
A Quality Over Quantity Auto Lending Strategy
Back to basics. Sure, there’s a lot of new technology. There’s also evolving expectations. And mediums. But it always comes back to the mission. Which, as you know, exemplifies quality over quantity, combined with great service.
Approach direct auto lending with this mindset, while adopting some or all of the strategies above. You’ll discover an auto loan channel that’s profitable without compromise, while creating more loyal members.
We’ve written a lot about Car Buying Services and auto lending. It’s also what we do. To learn more about our own offerings, visit cuZOOM.
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Focused on helping your bank or credit union grow in the face of emerging challenges.