Different from the 2008 recession, the current pandemic economy features a lot of competition for direct and indirect loans.
Last month, I shared with my readers several reasons why I believe that the COVID-19 recession is very much different than the Great Recession. Since the Great Recession is still fresh on most everyone’s mind, it’s natural to try to draw parallels between it and our COVID-19 recession. Yet in most cases, it’s hard to learn much from the Great Recession and apply it our critical business decisions right now.
A major chunk of the credit union industry’s business is in auto loans. Last month, I shared several things that are quite different in 2020 than in 2009 as it pertains to projecting loan losses. Let’s forget loan losses for now and focus on keeping our businesses growing. From that perspective, there also are a lot of things that are different now than they were in 2009.
Financial Market Stability
I recall all too well a conference call Ent Credit Union had with its asset-liability advisor in February 2009. The financial markets were, in a word, dysfunctional. Uncertainty about loan performance and the overall economy had scared off investors in auto loans—so much so that the market was demanding returns of upwards of 16% on a prime pool of loans.
It wasn’t an issue for credit unions as we didn’t rely on making loans and selling them. We had the liquidity. However, as soon as captive finance companies that didn’t have deposits to fund loan long-term loans made any loans, they were packaged as securities and sold off. At the time I believe our best rate for an A+ 60-month new car loan was in the 5% range. It’s not possible to originate a loan at 5% and package it and pay an investor 16%, at least not without taking a huge loss.
As a result, the captives were simply not lending. We credit unions had the auto market largely to ourselves, and virtually all of us that did indirect lending picked up some amazing market share during that time.
In 2020? The financial markets are stable. Auto loans, at least prime pools, are still performing fairly well, so we’re not experiencing the same disruption. In fact, the captive finance companies are being very aggressive right now. With alternative investment rates barely above zero, institutional investors are willing to buy loans with a very low rate of return. In addition, the captives are offering a lot of 0% loans to keep people buying cars, as the cost of funding those loans is so low.
The banks are still in the game as well. One of the large national banks provides the funding for several manufacturers, including Subaru. Our local Subaru dealer is the largest in the country, and over the last few months, we’ve lost a fair share of volume from this dealer. Last month we found out why: The bank is doing 72-month loans to A+ borrowers at 2.75%. That rate is almost a full 1% below what our best 72-month rate was between the financial crisis and 2015 when the Fed started raising rates, and almost 2% less than our 72-month rate now.
Why are the banks so aggressive? An inflow of cash from COVID-19 has the banks sitting on a lot of money with limited places to invest it. Credit cards and personal loans are seeing very high levels of repayments—as there is some evidence, empirical and anecdotal, that the COVID-19 stimulus checks and additional unemployment benefits have been used to pay down these higher cost forms of debt.
In addition, due to historically low mortgage rates, the lending industry is also experiencing a lot of home equity loan payoffs from first mortgage refinancing activity, so it’s hard to lend money and build balances in that portfolio. In short, there are not a lot of options for the banks to invest large amounts of money.
Technology in Lending
If you’re not in the indirect market, auto loans tend to be labor-intensive. First of all, there’s what I like to call a lot of “churn and burn.” You may find that it takes two to three approved auto loan applications to actually fund one loan. The cause? We all know it: The borrower that is pre-approved through a direct lender is susceptible to being converted at the dealership to a loan with a captive finance company. The convenience factor is hard to ignore.
But what happens as more and more consumers use contactless delivery and cars are delivered to their doors? We didn’t have that in 2009! Add to that potential trend a better user interface in the form of easier to use mobile loan applications, and there’s a really good chance that the next deal you should have gotten through your indirect program will involve a borrower who arranged his own loan.
Technology not only makes it easier to fund loans used to buy a car, but also to refinance a car. Going back to those historically low rates I wrote about earlier in this article, it’s a lot easier for lenders to target your existing loans with a refinance at a lower rate.
Strategy is the Root of All Evil (When It Comes to Auto Lending)
Whether you’re a direct or indirect lender, your strategic plan is a big driver for the quality of your portfolio. A good auto lending strategy will drive loan growth and quality. Absent a well-thought-out and well-executed strategy, you’ll likely suffer from weaker growth and/or credit problems. How can you shore up your auto lending strategy? A topic for next month!
Bill Vogeney is the chief revenue officer and self-professed lending geek at $7.1 billion Ent Credit Union, Colorado Springs.