Riding Used Car Wave, CUs Revive Residual Financing
- Members who use the financing tend to be loyal users.
- More options available at the end of term.
- Protections may be in place to protect credit unions from risk.
With a year-long track record of strong portfolio performance, used car loans continue to rev up a turbo boost for many credit unions.
So much so that some are seeking nontraditional methods to keep the lending momentum going. Among them, leases and balloon loans, which advocates say can bring in higher yields than traditional financing and potentially offer more savings for members on their monthly payments. Typically referred to as residual financing, the program requires less of a down payment, shorter loan terms and more options at the end of the term.
The $356 million Security Credit Union in Flint, Mich., has been offering a residual-based financing program since late 2011, said Chad Merrihew, vice president of operations. Members who sign on are able to get a low payment, flexible terms, actual ownership of the vehicle and several end-of-term options, including the lease-like option of being able to surrender the vehicle and walk away in lieu of making the final loan payment.
“We’ve seen substantial growth and we’re serving a niche for payment-sensitive members,” Merrihew said. “It also allows us to compete with others.”
Security CU partnered with Auto Financial Group, a Houston firm that provides residual-based finance products for credit unions. One of its programs aims to protect financial institutions by guaranteeing predetermined residual values, offering third-party insurance and allows for the ability to earn interest, according to the company.
Merrihew said Security CU’s leasing and balloon payment activity is a 50-50 split between new and used vehicles. By offering a lease-like loan, members have been able to get cars they normally wouldn’t be able to afford through an average savings of 30% to 40% on their monthly payments, he added. For the credit union, the yields are 1.5% to 3% higher than traditional financing.
“The dealers that are taking advantage of this type of program are sending substantial numbers to the credit union,” Merrihew said. “We’re hearing them say they’re moving their inventory much quicker than their competitors down the road.”
The competitors that most credit unions face in the vehicle lending space may have to rethink their financing strategies. Since February 2011, used vehicle loans have been among the biggest contributors to the industry’s overall lending numbers, according to the April edition of CUNA Mutual Group’s “Credit Union Trends Report,” which tracked data through February. At $6 billion, used vehicles were in second place behind first mortgages at $11.3 billion and ahead of member business loans at $2.8 billion.
“The used car market is hot right now,” said Richard Epley, CEO of Auto Financial Group. “The affordability issue is more prevalent for credit unions.”
Over the last few years, the danger here has been wanting to make vehicles so affordable for members that the loan terms were stretched out to eight and nine years, Epley noticed.
“We think that’s the wrong way to go because it buries the member in the car,” he said.
Members of the $898 million Corning Credit Union who have opted for a lease or a balloon payment have been a pretty loyal group to residual financing, said David Walker, vice president of lending. Years ago, the Corning, N.Y.-based cooperative offered such a program though a company that eventually went out of business. After a period of dormancy, members started asking for the financing option again.
“We found that members who are used to leasing or balloons keep coming back to them,” Walker said.
In the last quarter, 10% of Corning’s volume has come through residual financing for auto loans, Walker pointed out, adding that the three to four year terms have been much more attractive to members than the 84 or 96 months that some competitors have been offering. The credit union has also partnered with AIG.
Walker said the numbers tell the story. Corning financed 44 residual loans in the first quarter of this year. For the entire 2011, the credit union approved 41 loans, mostly on the indirect side. While he also anticipates used car lending will continue to heat up, 80% to 90% of Corning’s balloon and residual loans have come from the new car side. Still, members tend to look to the higher end used cars for residual financing.
In upstate New York where Corning is based, Walker said the competition is not cutthroat, but most of the matchups are with national banks. What has helped the credit union’s growth is educating local dealerships about residual financing and how it can benefit everyone involved.
“Members have several options at the end of the term,” Walker explained. “They can sell it out right and get more than the residual value or turn it back in to AIG and they resell it. Most of the vehicles turned in are being sold or traded.”
Like Corning, the $173 million GPO Federal Credit Union in New Hartford, N.Y., also brought back its residual financing program after a nearly five-year hiatus, said Gary Roback, vice president of member service. After offering the service a decade ago, it fell by the wayside. In the first quarter of 2010, GPO decided to give it another go with AIG and the re-entry has paid off.
“Just in the last year, from the first quarter of 2011 to 2012, activity on indirect has tripled in volume” Roback said. “We’ve seen some decent activity on used cars.”
One of the challenges in GPO’s market is finding good inventory, Roback said. Despite success with residual financing, the credit union’s competition from community, regional and national banks as well as other credit unions has been a factor.
“We have competitive rates but there’s always someone else low balling,” Roback noticed.
Years ago, some credit unions suffered financial hardships and as a result, tighter regulatory guidelines with their indirect lending programs. To this day, some acknowledge that it is still a struggle to establish long-term relationships with members who sign on through the indirect route.
Competition will also continue to be a factor.
“We’re competing with Allied Bank and captive finance companies and in some cases, we can’t compete because of the high residual values,” Merrihew said.