Seems like a strange question, right? It’s a thing you do. It’s a thing lots of financial institutions do. Millions of auto loans go through indirect channels each year. So what’s the issue?
We’re not sure the concept fits your community-focused mission. At its simplest, you’re just another lender on a list. Where is the evidence it truly benefits the borrower any more than a captive lender?
With the multitude of articles (each word is a separate link) we’ve written about indirect lending, it’s an answer which continues to be…”eh”. Our research finds discussion on current trends, profitability, and volume, not “benefit to community”.
It’s time to take a different approach. One which fits your goals financially and by the mission. Chances are, it’s similar to how you decide which products to offer and feature in your year-end performance back to members and the Board of Directors.
So, putting aside the bottom-line dollars, has your indirect program had a positive effect on your mission?
If that question made you stop for a moment, then we are all on the right journey. And this article is perfect for you. Let’s discover the answer together.
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The Growth of Indirect Auto Lending by Credit Unions
You know the story. A few years after the Great Recession (2008-2009) in 2011, traditional banks began to leave the indirect market. They had their reasons:
- Slim margins
- Higher delinquencies
- Inability to “convert” borrowers to primary account holders
Never fear. Credit unions are here! Many large credit unions, already with sizable indirect portfolios, were quick to jump on this opportunity. As a historic period of low interest rates continued, their volume grew. More credit unions got in on the action.
It didn’t take long for a majority of $250M+ asset-size credit unions to be offering indirect auto lending. Loan (and thus member) growth exceeded projections. In only 7 years, credit unions grew their share of all auto loans in the country from 17% to 24%.
This had a big role in passing the 100 million member benchmark in 2014, growing to 120 million in 2019.
Those are big numbers. And that’s a lot of loans. Impressive work to all those involved. So how did credit unions overcome the three main challenges that drove the big banks to exit the market? Had they found the “secret sauce”?
More importantly, as cause-driven financial institutions, were credit unions able to integrate indirect lending into their mission? To answer that, let’s take a look at how credit unions are managing their indirect portfolios. It relates, I promise.
Credit Unions & Indirect Lending Today
As credit unions grew their indirect portfolios, naysayers predicted increased delinquencies and repossessions. Yes, rates of each grew slightly, but not to concerning levels. Overall, indirect portfolios perform well.
That deserves a tip of our hat to your secure underwriting strategies and dealer management.
Margins, as you know, are slim, especially with interest rates at historic lows. However, indirect lending still creates a profitable path to grow more dollars from deposit accounts.
Larger credit unions, with the help of Wall Street, amplify their profits through another strategy. They package and “sell” portions of their loan portfolios as loan participations. This practice grows liquidity for the credit union while also reducing long-term risk.
So thinking back to the reasons banks left the indirect market, what were credit unions able to overcome?
- Slim margins: The margins are still slim. Credit unions continue to pay between 1-3% in dealer reserve fees for the business. However, between more used car financing and a focus on “B” and “C” paper, CUs saw wider margins and more respectable ROI.
- Increased risk: Credit systems today are fast and robust, giving dealers the fast approvals their customers (read: your members) expect. The platforms also help keep lender risk to a minimum. So far, it seems to be working.
- New member conversion: This still remains a challenge for most credit unions. (We even wrote a white paper and built a product for it!) Some CUs promote the benefits of membership, though for the most part, indirect borrowers are still “one and done”.
From this analysis, it appears indirect lending is a success for the credit union industry. They’ve overcome most of the reasons banks left the practice, so why does this article even exist?
Because even if you’re making money (which is still a matter of debate as you dig into the numbers), our topic today is to determine if it fits your mission. Read on to find out together.
Are Indirect-Acquired Members…Members?
Of course they are, right? They have all the privileges of a member. In every way, your indirect borrower is a member. But has indirect lending kept your mission constant?
For those people buying a car and “lucking out” to get financing from your institution, it worked in their favor. They got a competitive rate on their loan. You can introduce them to their new non-profit financial partner. More value can come from becoming an active member.
Unfortunately, that’s a difficult transition. We dove into onboarding as a company effort, spoke on it, and wrote at length. Onboarding these members is possible, just a challenge. Though one we believe is worth pursuing, for all the reasons you exist in the first place.
So growing your indirect channel from a mission standpoint has merit. It’s unlikely most will become fully onboarded members, but every one you do reach is an individual and community benefit. Of course, only then can you become their true financial guide.
Though that still leaves the issue of the dealer potentially promoting protection products (alliteration!) without fully understanding their needs…at a price far higher than your own.
Indirect & Your Current Members
How does indirect work with your current members? Is it mission-approved? Let’s first look at why you’d want to promote indirect to current members. Then we can answer that second question together.
Historically, most consumers preferred to start and finish their financing at the dealership. So having an indirect program made sense to keep your financing available as an option. Is it still necessary?
The percentage of customers financing at the dealer has been decreasing each year.
In 2018, 63 percent of U.S. vehicle buyers acquired financing at a dealership, according to FICO’s 2019 Consumer Survey of Vehicle Financing. That’s down 10 percentage points from only a year prior.
As you’d expect, the decrease continued through the pandemic, with savvy car and loan shoppers frequenting 3rd party car buying sites. Like your own car buying service, each features exclusive financing options.
Plus, more people are choosing remote and contactless lending to align with their digital car buying experience. With trends showing members shifting away from the traditional car buying path, is there a downside to promoting indirect for them?
Yes. Part of securing financing with your institution is the protection analysis. It’s your team’s responsibility to educate on possible member risks and help them understand which products, if any, make sense.
Sales, sure, but protecting your loan and their financial well-being matters. You could almost call it part of your mission. Is dealer financing in line with that strategy?
Indirect Financing Drawbacks
The main downside to indirect is its cost. Dealer reserves range from 1% to 3% of the financed amount. Then, you have expenses for the purchase and maintenance of the software platform (or service).
Depending on your provider, there could be time and resources required to properly manage the member experience.
From your member’s perspective, it’s not any more expensive than going direct, but they lose out on all that great education you definitely offer. Then, they’re walked over to the F&I office, where it can get expensive. Ok, so indirect can be more pricey for your member.
Did you know dealers make around a quarter of their profits from that office? I’m sure some staff truly care about ensuring buyers add only the right products for them. Yet with such a profit center, do you believe most think of it that way?
That’s probably a bit different from how your credit union treats members.
Of course, you know that their laundry list of protection products are almost always more expensive (sometimes double the price) than what you offer. And it’s not like they’re any better.
Not being able to offer and sell those products is a cost in lost non-interest income for your credit union. But the dealer made a bunch of money on your member, so…hooray?
Then there’s the poor member who passed on GAP because of its high dealer price and is now stuck with a massive claim they cannot afford. Is that serving your members?
Indirect costs both your institution and your members. On top of that, it doesn’t contribute to your mission.
Indirect During Change
As consumer habits evolve, credit unions may be best positioned to employ indirect lending only where necessary. The focus can transition to promoting the benefits of their car buying services.
This empowers your team to know when members are in the market, guiding them to your direct lending, while also educating and offering appropriate protection products. At the same time, this opens doors to deepening other aspects of their relationship.
There’s evidence this shift is already taking place.
According to a Fiserv report, overall credit union indirect loans decreased through 2019. Thus, at least prior to the pandemic, it appears the industry is returning to “more traditional growth strategies”…that just so happen to be more in line with your mission.
Does that ring true for your institution? We’ve noticed a “back to basics” approach for many as the impacts of COVID threw us all off our norms. Turning your focus inward to direct lending could be part of that “re-entering our comfort zones”.
Wouldn’t you agree “focusing 100% on our mission” is a nice shift to make?
Mission & Member Focus Continues
We built the Learning Library to make your due diligence work simpler. Getting info on a topic shouldn’t require jumping between 10 vendors, then setting up meetings for each to promote their service. You wouldn’t tolerate that for researching a TV. Why accept it for your products?
There’s also a second purpose: To further our mission of financial empowerment. Yes, it’s your mission, too. Only we find that some institutions forget how everything they do can contribute to this goal. Not yours, obviously, but some others.
Content like this, our Financial Empowerment section, and articles like the “5 Steps” series further that goal. We discuss how selling can be a form of protecting, education can be a tool to improve communities, and staff training really just creates opportunities for connection.
More than ever, people need help. From pandemic-induced financial challenges to systemic issues which DEI programs aim to reveal (and fix), there are lots of ways for you to make a difference. Beyond even what you typically consider, you can be a force for good to your members and greater community.
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Focused on helping your bank or credit union grow in the face of emerging challenges.