Is Indirect Lending a Romp In the Devil's Playground?
Getting members gained through indirect lending to become full members or multiproduct members has always been an issue of debate, but according to Brett Christensen, owner of CU Lending Advice LLC, the indirect lending business model as a whole is a failed model.
"I tried my hardest for 18 years to keep an open mind about indirect lending, and my mind isn't open anymore. In my opinion, it's a failed business model, but some of the biggest credit unions will deny it until the end," Christensen said. He went on to describe indirect lending as a "partnership with the devil."
The strategy at a credit union that offers indirect lending, Christensen said, consists of telling members to "just go down to a dealership, get ripped off and get the loan with us." Credit unions, he added, need to take a step back and make sure they have done everything to grow loans without dealerships.
Over his consulting career visiting and speaking to credit union executives about lending practices, Christensen cited some of the "carnage" he has seen from indirect lending programs.
"I saw a $600 million Southern credit union charge off $11 million in indirect auto loans in a two-year time period. I saw a $175 million credit union in the Southwest charge off $5 million one year and $6 million the next in indirect loans. I saw a $100 million credit union in the West charge off $ 1 million a month in indirect auto loans."
Growth is what propels credit unions to join indirect auto lending programs, Christensen said, but the growth can become addicting. Problems start to arise and large losses begin to build up because, he added, underwriters feel pressured to approve loans because senior management is so proud of the exceptional loan growth. Volume comes in so fast, employment, income and collateral verifications are not done, and the credit union's collectors are in a constant state of catch up once losses start to hit because collection efforts were not ramped up aggressively.
Wayne Tew, CEO of $626 million Clark County Credit Union in Las Vegas, discontinued his credit union's indirect lending program in early 2005, because he saw that there was very little margin after paying fees to dealers and keeping rates down and because there was a bias at the dealerships to give loans to credit unions with community charters.
"Despite the claims, there was very little member penetration. The members were mainly one account members," he added.
Now, Tew said, the credit union uses the same approached it had before it used indirect lending. It uses direct mail marketing and an aggressive sales group that cross sells products. The group receives large incentives based on what loans it brings in.
James Nastars, senior vice president, lending at $ 1 billion University Federal Credit Union in Austin, Texas, said that the credit union ended its indirect lending program in January 2000. University had been participating in an indirect program since 1993 that had been running successfully until 1997 when Nastars said the wheels started to come off.
"We charged off a significant number in 1997. And what we noticed was that a lot of the applications coming in had fraudulent or incorrect information. Some of that was our fault for not taking a better look at the application," he said.
The credit union decided to revamp and redirect the program, but pressure from dealers to buy bad loans pushed the CU to discontinue the program in 2000.
"Dealers would say to us, 'You need to relax your requirements' or 'If you don't buy these loans, we're not going to send you any loans.' The culture of the dealers was not consistent with the culture of our credit union," Nastars added.
In 2000, the credit union rolled out its Wheels 101 guide to members on on buying a vehicle.
"We saw disturbing figures for what members were being charged for cars and for guaranteed auto protection insurance. We decided we needed to be an advocate for our members," Nastars said.
The credit union also started car-buying seminars, the first one had 500 attendees, Nastars said, and overall the new approach to auto lending was well-received by members. He admitted that it is difficult when competing with other lenders and when you are not on-site at the dealer, but the credit union tries to earn the members' trust and get them into the credit union for preapproval before they buy the car.
"It keeps us on our feet to make sure the member gets to us first. We just started a vehicle buyers program where the member can take a check to a dealership to purchase a vehicle," Nastars said.
Though the new program was well-received by members, Nastars said dealers in the area gave the credit union flak when it decided to stop its indirect lending program and even threatened to sue the credit union for its Wheels 101 program. Some dealers refused to take UFCU financing, but now, after 10 years, Nastars said that they rarely get push back from dealers.
In Winston Salem, N.C., Truliant Federal Credit Union has been running an indirect auto lending program since May 2005. Troy Martens, vice president, consumer and real estate lending at Truliant said that the CU has procedures and policies in place to monitor the program to prevent losses from piling up. The underwriting staff is constantly communicating with the finance office at the dealership, the credit union audits the loans before they get funded, it has a sales staff actively at the dealerships and another audit is completed on the loans by an auditor outside of the credit union's indirect lending department.
The collections department at the credit union uses a different approach for indirect loans. Martens said that indirect loans typically see more first-time payment defaults because sometimes the member doesn't know where the loan went after leaving the dealer.
"With added risks, we've stepped up our training and have a tighter leash when it comes to indirect. Delinquency rates for our indirect loans are typically a little higher than our direct loans, so we treat them differently," he added.
Tony Boutelle, president/CEO of CUDL, said indirect loans typically perform according to their FICO scores because they are granted to new member. But loans to a credit union's current member base and SEGs typically perform above FICO scores.
"Credit unions can't go into an indirect program thinking these loans are going to perform as existing membership and SEG loans," Boutelle said.
Indirect lending, Boutelle said, is nothing more than a delivery channel.
"There is no doubt about it that it creates more risk for credit unions to manage. If you understand how to manage risk you will have success. All the things we give them are just tools credit unions need to take responsibility for managing the risk," he added. "We know working with dealers is not exactly what credit unions want to do but it's where members go to get financing."
Boutelle cited a 2008 J.D. Powers & Associates consumer financing satisfaction study that showed that 46% of consumers with luxury vehicle purchases and 50% of consumers with nonluxury purchases intend to have the dealership work out the best deal for them. Thirty-seven percent of consumers with luxury purchases and 33% of consumers with nonluxury purchases said they intend to work with the dealer to choose the financing options. Eight percent of consumers with luxury purchases and 6% of consumers with nonluxury purchases came in with a preapproval and used that lender. The results, Boutelle said, show why CUDL exists.
Christensen said credit unions that are not indirect lenders need to learn how to become professionals at stealing members back after they've already received financing through another lender at the dealership.
As a side project, Christensen said he is working on developing a credit union anti-indirect auto lending association where credit unions can share indirect lending war stories, ideas and learn how to grow without dealerships.