Scrutinize The Value Of Indirect Lending

Credit unions can weigh the value of indirect auto lending by comparing several financial metrics.

 
 

Credit unions increasingly developed indirect auto lending programs over the past few years, despite intense competition in auto lending, the record-low interest rate environment, and enticing offers and incentives from captive finance companies.

Indirect lending seems to boost 12-month auto loan growth even with with intense competition in the auto lending market, although credit unions with indirect lending tend to lag in loan yields.

To measure whether or not indirect lending had a positive impact on credit unions, Callahan & Associates compared credit unions with indirect loans to those without. Credit unions without indirect loans were limited to those with more than $50 million in assets to achieve a similar average asset size, and therefore a more accurate comparison to credit unions that participate in indirect lending.

The average amount of outstanding auto loans is nearly twice as much at credit unions with indirect loans as those without them, with an average balance of $65.6 million compared with $36.3 million. The annual growth of outstanding auto loans reveals a similar trend. Credit unions that do indirect lending have annual growth of auto loans of 4.0%, which is more than twice as fast as the 1.8% for their direct lending peers.

Indirect Lending Credit Union Comparison

Data as of March 31, 2012
 
 
Source: Callahan & Associates' Peer-to-Peer Software.

In spite of both higher balances and faster growth in auto loans, credit unions with indirect loans have an average overall loan yield 20 basis points below the 5.69% of credit unions without indirect loans. This is true even though credit unions with indirect loans have a larger average base of outstanding loans to earn interest income from.

Credit unions with indirect loans do report an ROA that is 10 basis points higher than their non-indirect lending peers, even though their operating expense base is also higher. However, the higher ROA is primarily due to a higher amount of non-interest income, a lower cost of funds, and a smaller provision for loan losses.

Indirect loan delinquency was 76 basis points in the first quarter for credit unions that participate in it. Delinquency for all loans, except indirect, at these credit unions was 1.58%, and the overall delinquency rate was 1.43%. Overall delinquency at credit unions that don’t participate in indirect lending was 1.48%.

As new auto sales continue to drive ahead, competition in the auto lending market will likely continue to be strong. Credit unions must balance the need to make loans with available funds while being mindful of managing interest rate risk. Indirect lending can benefit credit unions, but credit unions should be conscious of the intense competition in both indirect lending and new auto lending.


 

 

 

 

July 27, 2012


Comments

 
 
 
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  • Actually, just knowing the average net charge off ratio can mislead because any comparison of this ratio among lenders usually shows a significant variance from the mean. This is true for CUs, Banks, Captives, and Finance Companies. Even two of the largest indirect lenders in the US show a large variance - one large national indirect lender has a loss ratio of 46bp, while a comparable lender reports losses just over 500bp. In short, control of the credit loss expense is the critical factor in whether or not your indirect portfolio makes money or provides the red ink - and one should price to absorb expected and unexpected losses regardless of any lender group average.

    Another significant point in this otherwise excellent article is the comment about Indirect loan delinquency of 76bp being less than the delinquency non-indirect loans or total loans. It is important to understand that delinquency is masked during a growth phase, and credit performance should be evaluated on a static loss basis. An indirect loan portfolio with delinquency of 76bp during a growth spurt might equate to 400bp once the portfolio growth slows. This is akin to how great my golf drive looks off the tee during the first third of its trajectory - clearly, it is no indication of its long-term flight path into the woods.

    Finally, Phil's comment hits the strategic nail on the head. Of those that finance a vehicle purchase, 72% allow the dealer to control placement of the financing - so being at the point of sale to have a shot at these loans is key. A sound and appropriate-sized indirect lending program is a major advantage for a credit union. Indirect loans are the fastest and easiest way go gain a new member.

    The bottom line? Since the 60s lenders (of all stripes) have had a love/hate relationship with indirect lending. Why? Because the market rewards growth. And growth can come easy for the indirect lender that either a) buys too deep or b) prices too low. This is and has always been the Achilles Heel of this asset class. So this is not a business segment to "dabble in". Indirect lending is like a marriage. Either you commit or not, and if you do - it takes a lot of work but the rewards can be wonderful.
    Chas Roscow
     
     
     
  • Agree with both comments above. Most CU auto loan portfolio's distribution that I have seen are heavily weighted toward used in terms of growth. That means smaller average balances and difficult to keep up with the runoff of new loan portfolio as competition as noted is very strong. A direct loan channel that focuses on new vehicle loans can be helpful.
    Jeff Martin
     
     
     
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  • Prety well balanced article. Ultimately, the individual credit union must determine if indirect fits in with their overall srtategy. *The reality of auto lending is that regardless of how well intentioned members are to transact directly at the credit union or refinance at some point, most loans are consumated at the point of sale, so a sound indirect program should be a part of a credit union portfolio.
    Phil Maniaci
     
     
     
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  • This would be a great article if it included the net charge off ratio of both credit unions. Operating Expense Ratio does not include the Provision.
    Bill Brooks
     
     
     
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