Indirect Auto Lending: To Be or Not to Be
Many financial institutions in America are visiting the topic of indirect auto lending. Some are considering entering the business for the first time. Others are evaluating re-entering the business, while others are considering expanding their existing programs. At the same time, some wish to exit the business.
What is going on? Why would a lender consider entering or expanding in the indirect auto lending arena?
For one thing, indirect auto lending offers an ability to generate consumer loan volume and build members with minimal marketing expense. It also offers an opportunity to cross sell and up sell additional services to newly originated members, thus expanding an institutions share of wallet. Current economic conditions have reduced the number of traditional competitors and reduced the barriers to entry to this line of business, making indirect lending an easy line of business to enter or expand. And dealers are searching to develop relationships with lenders who are committed to providing consistent lending decisions over time-not hot and cold or in and out of the market. Indirect lending pricing opportunities and operating efficiencies can lead to higher returns than branch originated consumer loans.
If yours is an organization evaluating the opportunities of indirect auto lending, you will want to factor in the following keys for success.
o A comprehensive and thorough understanding of indirect dealer lending and the dealer industry.
o A well thought out business plan that incorporates an effective front-to-back risk management program and tracks loan origination applications and credit quality characteristics as well as daily, weekly, monthly and annual portfolio performance metrics. Recall the time proven adage, "If you cannot measure it, you cannot manage it."
o Build, maintain and enhance relationships only with quality dealers who retail and service quality products.
o Solid and competitive underwriting standards that are consistently applied, tracked and reported. If portfolio performance indicates a change in credit policy is necessary, such changes must be developed and adopted quickly.
o Market competitive pricing (not necessarily as the market leader) to achieve credit and profitability objectives while avoiding risks of adverse selection.
o Adverse selection is a risk that must be minimized through pricing and thorough new loan origination analysis.
o Operating and origination costs must be tightly controlled. The proper ratio of booked loans divided by applications processed is critical. "Booked to approved" is important, but "booked to looked" will be the most critical operating ratio that will determine operating profit.
Each of the above keys to success are critical components of a successful indirect auto lending program. A miss in any one area can lead to disappointing and, in some cases, potentially disastrous results.
Now, let's examine why some lenders have left or are considering leaving this business. Leading reasons include, loan losses or program operating expenses are of such magnitude that staying the course is no longer an option; capital constraints have forced many major players to focus on maintaining or growing capital instead of making loans that require appropriate loss reserves; and guidance and encouragement from regulators to forecast and increase loan-loss reserves in light of recessionary conditions is extreme, and management and directors are all feeling the pressure.
If your organization is considering an exit from indirect auto lending, you may wish to consider locating a buyer for your existing loans. To leave them on your books will be problematic with increasing delinquency and loan-loss ratios as the portfolio runs off with good loans paying off at a more rapid rate than bad loans. Additionally, the servicing cost per booked loan will rise over time since you will need to operate your indirect auto loan accounting system until the final loan is paid off.
Whether your institution is considering entering, growing or exiting the indirect auto lending business, thoughtful consideration of the above is essential. Seasoned third-party advice and counsel is available.
W.F. Henle is a principal at OFCG Strategic Advisors. He can be reached at 916-259-2137 or firstname.lastname@example.org