As Banks Slow Indirect Auto Lending, Should CUs Step Up Their Game?

Now that auto lending (in tandem with auto sales) has scaled all-time highs in the United States, some banks – including Fifth Third and Citizens Financial Group – are beginning to scale back their indirect lending presence due to rising delinquencies, shrinking yields and escalating competition. But the banks' moves, analysts say, could clear a path for credit unions, even as overall auto lending begins to trend back to more normal levels.

According to the New York Fed, total auto loan volumes domestically reached $1.1 trillion during the second quarter of this year. However, as these figures have mushroomed, credit quality is worsening. Part of the problem for some banks has to do with their relaxation of underwriting standards in order to compete in an increasingly crowded marketplace. "As banks have competed for market share, some banks have responded with less stringent underwriting standards for direct and indirect auto loans," the Office of the Comptroller of the Currency said in a report.

Indirect auto lending has long been a staple credit union product, and many experts contend that it still presents good opportunities for credit unions, provided lenders are aware of the risks.

Tony Boutelle, president and CEO of CU Direct, a lending technology and automotive solutions provider for credit unions based in Ontario, Calif., said that whether or not credit unions want to increase their presence in indirect auto lending would depend upon each institution and also their region.

"But overall, we are hearing from our credit union clients that they want to get more into auto lending," Boutelle stated. "We don't really worry that much about what banks are doing – credit unions already have great analytics and portfolio management skills."

Chuck Price, vice president of lending at Nassau Educators FCU, a $2.5 billion institution based in Westbury, New York, said that indirect lending – like all business lines – needs to viewed and evaluated as one part of a credit union's overall lending strategy.

"It may fit into the risk/reward appetite [or it] may not," he cautioned. "If a particular credit union can meet yield hurdles in the indirect business and they are prepared to deal with the origination and servicing issues then they should develop a program that suits their needs."

Michael Taylor, assistant vice president of indirect lending at Connex Credit Union, a $471 million institution based in North Haven, Conn., said that any financial institution, including credit unions, must prepare for all the ups and downs inherent in indirect auto lending.

"It is an opportunity for credit unions to enter the business, but they must have established strong relationships with the dealers and have various controls in place," he said. "Clearly, some banks are pulling out because they have not found this business profitable, most likely due to lax underwriting guidelines."

Ahmed Campbell, vice president of loan operations at the $2.4 billion New York-based Municipal Credit Union, called the banks' decision to scale back a kind of "market correction" – that is, a response to some of the excesses that have led to some negative outcomes for some financial institutions.

But Campbell also said indirect loans could potentially provide increased opportunities for credit unions – but only if they are well-prepared and well-versed in the nuances of the trade.

"With indirect auto lending, you must be savvy, perform due diligence and have excellent relations and communications with the dealers," he said. "It's not a business one should jump into without doing a lot of homework."

According to Brian Turner, president of Meridian Economics LLC, Plano, Texas, delinquency rates for credit union-issued indirect auto loans (0.61%) fall below the total loan delinquency rate of 0.85%, suggesting solid underwriting practices.

Double the Pace of Direct

Data from Callahan & Associates shows credit unions had about $283 billion in auto loans outstanding as of June 2016, and about $152 billion of that total comprised indirect loans, compared to $131 billion in direct lending. And while many CUs have long offered indirect lending, that product didn't surpass direct auto loans until early 2015. Moreover, in just two years, between June 2013 and June 2015, the credit union indirect auto loan market increased by 50%, while the direct loan market expanded up only by 25%.

But ironically, while indirect lending now accounts for a majority of credit union auto loan originations, it is embraced by only a minority of credit unions. Jeremy Alicandri, managing director at Maryann Keller & Associates LLC, a global automotive consultancy based in Greenwich, Conn., commented that many credit unions have been slow to embrace relationships with dealers, therefore relying on their members to bring a "blank check" to a dealer, a dependency that often results in the dealer switching the credit union member to a lender that partners with the dealer via the indirect channel.

But G. Michael Moebs, economist & CEO at Moebs $ervices in Lake Forest, Ill., said that indirect auto lending is an area that credit unions should avoid, citing that it is a "very low margin business."

"In addition, as several large credit unions and banks have found out [that] cross-selling opportunities are almost non-existent," he said. "Ford Motor Credit Co. [the financial services arm of Ford Motor Co.] is the master at doing this. Unless you can achieve the daily volume of Ford Motor Credit, credit unions should stick to direct selling of vehicle loans."

Risk vs. Reward

CUs must also consider risk and underwriting factors in this discussion.

Alicandri believes that within certain credit tiers, CUs may have an opportunity as the banks scale back their lending. "Keep in mind, many banks are reducing their risk appetite in auto lending, and therefore pulling back on non-prime lending," he explained.

Moreover, credit unions are already "careful lenders. "And because common bond memberships often center around employers, credit union members typically have steady employment," he added. "The credit union, by its nature, has real information about the member's financial status since they often obtain credit card and mortgage statements that demonstrate a history of payments rather than solely examining a credit report, as banks typically do." These extra measures, he emphasizes, strengthen the quality of credit unions auto loans significantly.

"Thus, [even] if a bank turns down a borrower, a credit union may be able to approve the borrower while staying within the credit union's underwriting standards," Alicandri stated.

Campbell of MCU indicated that credit unions need to avoid the trap of seeking to increase loan volumes by loosening underwriting protocols – a practice many banks succumbed to – while adjusting pricing models.