Last November, Member One Federal Credit Union ($679.8M, Roanoke, VA) accomplished something that cooperatives often hesitate to do. The credit union changed the way it compensated dealers for auto loans, switching from a rate markup to a flat fee in part because of recommendations from the Consumer Financial Protection Bureau.
Because dealers took a slight haircut with the flat fee, Member One was fully prepared for the backlash, anticipating as much as a 20% drop in its auto lending business.
“Other leading lenders in our market hadn’t gone to flat fees, and we were initially concerned about changing that process,” says Tim Rowe, chief risk officer at Member One.
Then the unexpected happened. Dealers liked the change, preferring the simplicity of the flat fee to a markup plan that could cause rate confusion. Since instituting the switch in November 2013, Member One has enjoyed a boom in business, with the dollar value and number of auto loans it originates up more than 40%. The successful switch is a reminder that credit unions sometimes have more leverage with dealers than they think especially if an institution has built up its market share over time.
When Member One first started its indirect lending program in 2000, the credit union had exactly zero leverage thanks to a modest 8% auto loan penetration rate and a puny 2% market share. In fact, far from being in a position to negotiate a fee structure with its dealer partners, Member One needed them more than the other way around.
“To stem the flow of business that our members took elsewhere, we initiated our indirect lending program to help put us on a level playing field with other lenders,” Rowe says. “And that meant paying the rate markup, which was the way that loans were made at dealerships.”
The exact dealer markup rate varies depending on the lender (a credit union or other financial institution) and sometimes it varies even between programs at the same lender. A rate markup of 2% could also fluctuate based on interest rates, terms, dollar amount, new vs. used, and credit score. As an unproven auto lender in the region, Member One had no choice but to accept the dealers’ terms, even though most credit unions opt for the flat fee instead.
By 2013, however, Member One had become enough of a lending powerhouse that it could flex a little muscle and announce the new flat fee to its dealer partners. As of 1Q 2014, Member One’s auto loan penetration rate stands at 22.6% compared to a national average of 16.7% for all credit unions, according to Callahan & Associates Peer-to-Peer data. The credit union also commands a much larger market share of 15%, up from 10% just last year.
A Simpler Fee Structure
With a flat fee, a credit union might pay the dealer 1% of the financing over the loan term instead of marking up the interest rate, which would normally cost more and is more vulnerable to change.
An added benefit is the fee’s simplicity. Under the old system of marked up rates, borrowers could get a different rate depending on whether they financed the loan at the credit union or the dealership. The system was confusing not only to members but even to dealership personnel and the credit union’s own staff. Having a common rate simplified things for everyone by eliminating an extra step from the auto buying process, which was the back and forth discussions between the credit union and dealer to sort out the rate markup confusion.
In addition, the credit union hired a dealer representative who travels to Member One’s dealer partners to facilitate financing. The credit union has also hired more underwriters to keep up with the increased loan application volume.
“The dealers welcome the change,” Rowe says. But they may not be the first to recommend the flat fee because it means less money for them, he adds.
As for why dealers should get a kickback at all, Rowe views the fee as a necessary marketing expense because members want one stop shopping at the dealership. Without the fee, dealers would have no incentive to send the business back to Member One.
“We would rather make the loans ourselves and have members separate financing from the auto purchase and the trade in and have three distinct transactions,” Rowe says. But there’s one problem. “Nobody wants to do business that way.”