Throughout the recession, budget-conscious consumers have opted to hold onto their vehicles rather than trade them in and up. The average age of a car on the road in the United States steadily increased from 1995 to 2011, when it hit 11 years, according to USA Today. Now that the economy is rebounding, so too are new car sales, and one credit union is wasting no time spinning its wheels.
“People are payment sensitive,” says Brian Leonard, chief lending officer at Farmers Insurance Group Federal Credit Union ($642.2M, Los Angeles). “If you give them attractive long-term financing, they will come to you for the loan.”
Over the past year, the credit union has enlarged its auto loan portfolio 22% to $65 million and beefed up its financing of new cars — which it categorizes as anything less than two years old — 33%. Incredibly, Farmers has achieved this growth in a property market that suffered from nearly half a million mortgage defaults in 2009 and while managing to shrink its own delinquency rate from higher than 3% last year to 1% now.
Even more remarkable, the credit union does not make indirect loans and its field of membership is limited to Farmers employees and its network of real estate and insurance agents. But Farmers embraces its parameters, and focuses on new cars and good credit to ensure rapid growth doesn’t come at the expensive of quality loans.
Targeting “A” Borrowers
An aggressive marketing campaign to Farmers agents resulted in a 4% increase in membership over the past year. And although some of the loan portfolio’s growth comes from that membership bump, the credit union attributes the lion’s share of the growth to how it positions itself.
From its own research, Farmers discovered members are more inclined to use credit union services, especially loans, when they directly deposit their paycheck into a credit union account. That direct deposit is a strong indication the credit union is the member’s primary financial institution. To further encourage the connection between direct-deposited paychecks and service usage, Farmers offers all members with direct deposit an automatic 50-basis-point discount for any loan, no matter its duration.
Farmers considers any member with a 660 or higher credit score to be a top tier borrower and therefore eligible for the most attractive interest rates. The credit union aggressively prices its loans and offers an ongoing 1.49% promotional rate for borrowers with the best credit. Getting these members through the door raises the portfolio’s overall quality. But even borrowers with credit scores of 550 or less won’t pay more than 12% for a long-term auto loan, Leonard says.
And when it comes to duration, Farmers offers the same rates for its longer-term loans, including 72 months, as its shorter-terms loans.
“We didn’t increase the rate because most car loans turn over in 22 or 24 months,” Leonard says. In fact, Farmers’ entire auto loan portfolio turns over roughly every two years thanks to the number of borrowers who pay off their balances during that time.
Targeting New Car Loans
To finance more new cars, though, Farmers needed a different tactic. So, it offers up to 130% financing to cover the cost of a new car as well as the remaining balance on an existing loan where the borrower owes more than the vehicle is worth. Too risky? It might appear that way, but the credit union has sound reasoning.
“A lot of institutions won’t finance negative equity on the car that’s trading in,” Leonard says. “We only do that with people who have good-to-excellent credit because we would have given that person an unsecured loan anyway.”
In addition, Farmers’ new car loan interest rates are 25 basis points lower than those for used cars. And to entice members to refinance a nearly new auto loan with the credit union, Farmers considers any vehicle that is less than two years old to be new and therefore qualifies for the 25-basis-point discount. According to Leonard, loan balances in Farmers’ portfolio of new and used cars average approximately $20,000.
Attracting high-quality loans only accounts for some of Farmers’ success in lowering its delinquency rate. The rest comes from keeping a close eye on the portfolio’s performance. Every 90 days, Farmers crunches the numbers to see whether the portfolio met its target, typically 5%, for an average weighted yield. Then Farmers adjusts any pricing of loans accordingly before estimating the next quarter’s performance using new data for car valuations and credit scores.
“We forecast that we’re going to get this many loans at the 720 score and this many at 600 and at 500 and so on,” Leonard says. “Then we run the yields. In 90 days, we look at it again and see how we did.”
Careful monitoring of the portfolio’s performance also keeps defaults to a minimum. Through the first quarter of this year, Farmers had an annualized net charge-off ratio of 0.09%, the percentage that the credit union writes off as a loss after recovering whatever it can from any delinquent car loans. As recently as two years ago, the ratio was 0.50%. Like many credit unions, Farmers’ in-house collection department contacts borrowers whose payments are more than 30 days late. And for the members who are struggling the most, the credit union restructures the loan to minimize defaults.
“Because we look at our entire portfolio every 90 days, we have a handle on what’s happening with it,” Leonard says. “If delinquencies go up, we’ll make adjustments to our program.”
It adjusts, but the credit union is careful to not overestimate risk and price its loans too conservatively.
“If you shoot your rates up too high, people just aren’t going to do that deal.”