A Modern Credit Union’s Approach to Auto Lending
In 2011, I moved from Germany to the United States to go to graduate school. Following the advice of the Student Life office, I opened my first bank account with Stanford Federal Credit Union. No other bank would have easily opened an account for a foreigner with no credit history, no permanent address and no social security number. Stanford Federal Credit Union did!
After graduating from Stanford in 2013, my business school classmate Chris Coleman and I started a digital car retailer, raised $10M in venture funding by 2015 and sold the business to Carvana.com in 2017. Stanford Federal Credit Union supported me on this journey by giving me my first credit card and helping me build credit through a personal loan. Credit Unions really care about the financial well-being of their members.
After staying with Carvana.com for three years, Chris and I became enamored with the Credit Unions’ mission: too many Americans are overpaying on their vehicle expenses and dealers don’t have the car shoppers’ best financial interest in mind. We strongly believe that Credit Unions could become the healthcare system for the financial wellness of Americans.
Technology and digitization is the path to get there and the shutdowns following the COVID-19 outbreak will turn out as a blessing in disguise for Credit Unions.
The pandemic drove Credit Union deposits up and revenue down
When COVID-19 started to spread through the United States in early March, the government ordered the painful shutdown of retail businesses. As a result of these shutdowns, businesses suffered and the stock market crashed. Credit Union members withdrew capital from equity markets resulting in a sharp deposit increase. Moreover, Credit Unions saw a huge influx of dollars that came because of the COVID stimulus money.
... auto loan portfolios generally perform well for us during tough times.
After the FED lowered the rates to the rock-bottom, Credit Union leaders found themselves in unchartered territory: where can the Credit Union deploy capital effectively when the risk-free assets don’t generate any yield?
Jack Jordan Executive Vice President and COO of Velocity Credit Union explained to us: “Credit Unions took a beating in the 2008 recession on mortgages and mortgage-backed securities, and we have also seen loss exposure in their commercial loan portfolios in past recessions and during the current crisis. But auto loan portfolios generally perform well for us during tough times. They are well diversified through our broad field of membership, occupational categories and geographic dispersion. And with relatively small loan sizes, the risks from any one borrower or segment of borrowers is more broadly distributed. Car loans usually perform well for us even when losses on other types of loans increase.”
Hence the solution seems to be at hand: Credit Unions ‘just’ need to originate more auto loans, which solves the immediate business challenge and aligns with what is best for the members.
Auto loans are the Credit Union’s preferred asset class
Auto loans have proven to be a great member acquisition channel in the past. Moreover, Credit Unions understand them very well and are experts at pricing the risk. Encouragingly, Credit Unions have three channels to deploy capital:
Buy wholesale loan portfolios: Credit Union CFOs appreciate wholesale auto loan portfolios. Instead of deploying capital through originating one loan after the next, buying a whole portfolio is an efficient way to deploy large amounts of capital all at once. With the FEDs rate at the rock-bottom, the prices for auto loan portfolios have risen and yields have decreased as well. Moreover, through buying loan portfolios, the Credit Union won’t add new members - a loan portfolio is really just another asset class.
Do more indirect lending: Since Americans have been avoiding public transport, car sales have skyrocketed since the beginning of the pandemic. Hence, dealers are able to predictably originate auto loans for indirect lenders. Credit Union Chief Lending Officers, however, don’t appreciate indirect lending: the loans perform worse than direct loans and borrowers rarely become engaged members.
Do more direct lending: Credit Unions offer the best loan products. Hence, you would expect that Credit Union members naturally gravitate towards paying for cars with a Credit Union loan. Frustratingly, dealers flip pre-approved members from their Credit Union loan into loans from other institutions to earn more backend profit. Proactively deploying more capital through direct lending has therefore been a challenge for Credit Unions.
We’ve learned that Credit Union leaders developed two different strategies to make indirect lending work:
(1) Build strong relationships with local dealers
Eric Bugger, Chief Lending Officer from Wright Patt Credit Union shared with us: “We have very good relationships with our local dealers and originate a significant percentage of our auto loans through the indirect channel. As we speak, we're exploring how to grow wallet share of our members through a number of direct auto loan opportunities.”
(2) Partner very closely / invest in a dealership
Brett Martinez, President and CEO from Redwood CU chose a different approach: ‘Our Credit Union has seen tremendous growth. We are one of only two Credit Unions in the entire country who own a car dealership. Through our car dealership, we are providing our members a unique car buying experience and ensure the loans are not getting flipped. It also ensures our members get into a good quality car that they can afford. Which is ultimately the reason we opened the dealership’.
Another interesting way to originate direct auto loans from new members is through refinancing. A number of refinance brokers acquire customers through affiliate partners and physical mailers, collect all the stips and hand them to Credit Unions as loans that are ready-to-fund. Since margins for these refinance brokers are low, they all turn into call center F&I departments: while lowering the car owner’s auto loan rate, the brokers charge refinance fees of $399 and more and stuff service contracts and GAP insurance into the new loan to generate margin.
Therefore, refinance brokers usually come and go and don’t become reliable partners to originate direct auto loans at scale. The real auto loan refinance opportunities are the Credit Union’s own members. Due to dealers flipping pre-approved members into other loans, Credit Unions will find that the majority of their members have a loan somewhere else.
Through personalized marketing campaigns and an effective loan onboarding experience, Credit Unions could theoretically originate large volumes of direct auto loans from their own member base. If a member has challenged credit and made her auto loan payments in the past, we’ve observed that Credit Unions can even relax their underwriting standards without running incremental risk.
A digital experience adds value to both the consumer and lender by addressing existing and latent needs on both ends.’
In our conversations with Erin Mendez from Patelco Credit Union, the CEO and President told us about Patelco's successful Switch to Save initiative. We therefore strongly believe that Credit Unions can deploy capital into more auto loans through targeting their own members. To do so, we’re building on a turnkey solution to originate ready-to-fund direct auto loans.
Create a turnkey solution to originate direct auto loans
Aleks Bogoeski, Vice President Of Strategic Alliances at CUDL presented at the recent Auto Finance Summit and reiterated that some lenders are entering the refinance auto market looking to make up lost volume in the indirect space. Aleks explained that lenders are looking for ‘a fully digitized consumer auto refinance experience. A digital experience adds value to both the consumer and lender by addressing existing and latent needs on both ends.’
On one of our regular catch-up calls with Kirk Drake from Ongoing Operations, Kirk agreed with our takeaways: 'due to COVID-19, Credit Unions are sitting on higher deposits and have less revenue. Your technology enabling Credit Unions to deploy more capital with their own members is therefore very timely. Your experience helping Carvana grow their business is very applicable to the opportunities Credit Unions have ahead of them.'
After selling our last business to Carvana in 2017, I started the Sell To Carvana vertical. When we joined, Carvana was buying 134 cars per month from consumers. When we left in June 2020, Carvana bought more than 22,000 cars per month from consumers:
During the three years I ran the Sell To Carvana business, my main focus was on building out a turnkey technology solution to buy cars from consumers 100% online. Although it might sound counter-intuitive, the process of buying a car and the process of originating a loan from an existing Credit Union member are surprisingly analogous:
To help Credit Unions turn existing members with loans at other banks into Credit Union loans, Chris and I designed a turnkey technology stack: instead of running a spray-and-pray pre-qual campaign, our process starts with highly analytical propensity analyses followed by extremely personalized email campaigns. We leverage APIs and integrations to convert member interest into loans that 'almost magically' show up in the Credit Union’s loan origination system (LOS) thanks to our highly efficient conversion funnel. The design of our system foresees supporting Credit Unions with their back-office work.
Your experience helping Carvana grow their business is very applicable to the opportunities Credit Unions have ahead of them.
Our ambitions are very aligned with the digitally progressive Credit Unions. Caleb Cook from Digital Credit Union for example phrased it the following way: “through our DCU FinTech Innovation Center, we’re meeting exceptional entrepreneurs. We’re continuously trying to stay at the forefront of technology and are often early adopters. We’re now looking for technology that cranks out ready-to-fund car loans and helps the Credit Union and our members.”
The direct business has always been tough, what has changed?
If originating direct auto loans from the Credit Union’s own members was so easy, why haven’t other software developers been able to figure this out yet? In ‘The Innovator's Dilemma’, the Harvard Business School professor Clayton Christensen explains how new technologies cause great firms to fail. Often, great firms don’t pursue opportunities that distract from the core business, which creates opportunities for innovators.
If you’re able to capture more of the member’s wallet in a turnkey way, you will have the Credit Union leaders’ attention.
Historically, Credit Unions used to be very branch-centric. Members enjoyed the personal touch. The COVID-19 outbreak and the shutdowns, however, have changed consumer behavior. The pandemic marks an inflection point, compressing five years of Credit Unions digitization into five months. We therefore see the consumer behavior change following the pandemic as a blessing in disguise.
Jon Jeffreys from Callahan & Associates recently explained to us: 'when building technology for Credit Union, be aware that some of them are very progressive and others still need to catch up with technology. If you’re able to capture more of the member’s wallet in a turnkey way, you will have the Credit Union leaders’ attention.'
We’ve learned that historically, Credit Unions struggled to recapture their members auto loans for a number of reasons:
‘It’s hard to cross-sell members. We've tried it before.'
Cross-selling requires the member’s attention. Since the branch used to be the main member touchpoint, member representatives didn’t have a lot of opportunities to engage a member. Moreover, members love Credit Unions because unlike commercial banks, Credit Unions ‘aren’t trying to sell you something all the time.’
In a digital world, Credit Unions can engage their members subtly and in extremely personalized ways. Member representatives don’t need a strong sales mentality. Tailored campaigns convert successfully when designed with a human touch and presented to members at the right time with the right offer in the right way.
‘Dealers might get angry. We are somewhat dependent on the indirect channel.'
Credit Unions have the best loan products and comparing rates has never been easier than today. The minute Credit Unions experience the success of recapturing their own members who have loans somewhere else, the fear of challenging the indirect channel will fade. With a turkey tool to convert existing members into direct auto loans, Credit Unions will become independent of dealerships.
‘Software is expensive and takes a long time to implement.’
Every Credit Union has an IT or technology team these days. These teams, however, are usually fully occupied with maintaining and polishing the existing systems. Seven years in digital car retail taught us a number of valuable lessons. With regard to technology, smart buy versus build decisions have proven to be key to success.
Instead of developing technology that turns your members into direct auto loans, Credit Unions can now buy turnkey tools that are plug & play. Our pricing philosophy has always been: ‘we only want to win when the Credit Union and its members win.’ If we don’t drive incremental loan volume, we don’t expect to be compensated healthily.
‘Incremental direct loans will drive labor cost and create friction.’
With all that’s going on in the world, the most important thing for Credit Unions is to keep things lubricated and to remove frictions of incumbent technologies. The challenge with the incumbent technologies, however, is that they were designed to power the branch-centric Credit Union.
Trying to make incumbent technologies be the backbone of the digital experience members are looking for is like forcing a round peg in a square hole. We design our technologies customer-centric. That means, we automate processes that historically required manual labor and bridge gaps that historically caused friction.
Our Credit Union early adopter program
There is so much software out there, it’s easy to feel paralyzed. As a Credit Union leader, how do you know you’re making the right decision? Take a look at the following demo and let us know what you think:
As we speak, we have a waiting list of interested Credit Unions who are eager to expand their lending portfolios, and better serve their existing member base. If you are a Credit Union leader and think your Credit Union may benefit from participating in our 'early adopter program', please email us at email@example.com.