Extremely bad credit auto loan

How can CUs face the challenges of Web-based lending and below-market financing?

Credit unions' bread and butter is in a jam. Credit unions' new-car loans outstanding declined 3% last year, according to preliminary year-end 1998 data from the National Credit Union Administration (NCUA). The 3% drop seems even worse, however, in light of the fact it occurred during a year when new-car sales totaled 15.6 million-the highest level in 12 years and the third-highest total on record.

New-auto loans accounted for 18.7% of credit unions' loan portfolios as of January, down from 24.1% at year-end 1995. Credit unions' market share of all auto loans fell from 22.7% at year-end 1997 to 21.6% at year-end 1998.

Any way you slice it, the main culprit is captive finance companies' below-market incentive financing. Auto makers and their finance companies were extremely aggressive in offering incentives last year: The average cash-back offer for the first half of 1998 was $1,040, notes Mike Schenk, vice president of CUNA & Affiliates' economics and statistics department. That rose to $1,500 after the General Motors strike, as the auto manufacturer tried to lure customers back to showrooms.

"Rebates usually move in tandem with low-rate financing," Schenk explains. "So when cash-back offers start to get better, low-rate financing gets better. I've seen offers of 0.9% for 60 months. It's tough to compete with that."

The bad news is that below-market financing isn't going away. "When incentive financing first came out, it was supposedly a short-term move to help auto makers through a rough period. Now it's a way of life," Schenk says. "And most credit unions haven't been getting into indirect lending. Only 8.5% of credit unions are involved in such lending arrangements. That's a weakness in many respects because if you're not at the point of purchase, it's more difficult to get car buyers' attention. "

One auto industry analyst even predicts captives will edge credit unions and banks out of the new-car lending business altogether. "Margins on new-car loans will continue to shrink to a point that banks will find unprofitable," predicts Maryann Keller, managing director at ING Baring Furman Selz in New York, reported in American Banker Online. "Auto companies have the advantage because they take profit from the car and the loan."

Schenk expects credit unions' new-car lending will remain weak throughout 1999 due to a slower economy and a resulting decline in consumer confidence. Plus, auto manufacturers predict auto sales will fall to a range of 14.7 million to 15.2 million this year.

Fortunately, credit unions have two advantages over the captives: lower cost of funds and the ability to offer members a full range of financial services. It remains to be seen, however, whether credit unions can parlay those advantages into auto lending success in the face of captives' below-market interest rates and another burgeoning trend-Web-based auto sales and financing.

The omnipresent Internet

In 1998, more than two million consumers used the Internet when making a new-car purchase decision, according to a report by Forrester Research in Cambridge, Mass. By 2003, the Internet will influence more than eight million car purchases, and 470,000 households will purchase vehicles worth $12 billion entirely over the Internet, the report predicts.

The on-line car sales process has four distinct phases, the Forrester report says: general research, dealer selection, payment plans and insurance, and sale completion. "Consumers will be slow to move beyond the first two established stages until they gain confidence in on-line transactions."

Although 61% of new-car dealers have Web sites-a 53% increase from a year ago-their Internet auto sales have been slow, according to the National Automobile Dealers Association (NADA) in McLean, Va. Dealers report selling only 5.3 vehicles per month via the Web, even though 65% of dealers have a trained salesperson to handle on-line prospects.

Although current volume for Web-based auto sales and auto financing isn't substantial, it probably will be. Nearly 40% of auto loan originations will move to the Internet by 2005, although one-third won't do so because of security concerns, predicts a study by Killen & Associates, Palo Alto, Calif. "Firms failing to adapt their loan services to the Internet are especially vulnerable to loss of market share," the study warns.

In fact, robust on-line commerce could reduce the number of U.S. auto dealers from 22,000 to 10,000, according to a recent report by Stanford (Calif.) University's Graduate School of Business.

"My guess is that actual financing over the Internet right now is still low," says Schenk. "But if it catches on, it could be a huge deal for credit unions. It's not uncommon to get on a Web site and find ads for auto financing. You can click on a financial site and be approved for a loan within five minutes. And the rates are extremely low. "

While only 5% of Baxter Credit Union's auto lending business comes via its Web site, "it was 0% a year ago," says Jim Block, director of lending for the $510 million asset credit union in Deerfield, Ill. And he believes it will probably grow 2% to 3% per year.

"That's not explosive growth because most people want to talk to a human being and get reassurance they're making the right car loan decision," Block says. "But there's definitely a segment that's Internet savvy, and that segment will be growing. We try to be members' first place to go when they're looking for a car and financing."

Baxter Credit Union has an auto locator on its Web site and prenegotiates pricing with its network of preferred dealers.

A member-friendly option

For its new Web site, $28 million asset SPE Federal Credit Union in State College, Pa., introduced Credit Union Car Club-a car-buying service CUNA Service Group offers in partnership with San Francisco-based Consumers Car Club.

The service, available to members of participating credit unions on the Internet or by phone, offers price discounts on new vehicles and a hassle-free buying experience, notes Ellis Waller, CUNA Service Group's product manager for automotive products. Credit unions receive a loan lead each time a member uses the service, and dealers gain sales leads without incurring sales and advertising costs.

Credit Union Car Club offers three services: New Car Referral sends members free of charge to a participating dealer to close the deal in person; Personal Car Shopper provides an agent to negotiate price and handle purchase details for a fee; and Custom Factory Ordering lets members custom order from the factory for a small fee. There are no fees for participating credit unions.

Credit unions in five states began offering the service in January. All state leagues will be invited to participate, Waller says. CUNA Service Group also offers its Carfax Vehicle History Reports to help members shopping for used cars.

SPE Federal offers Credit Union Car Club to boost its new-car loan portfolio, stagnant due to captive finance companies' low-rate incentives. Because the service is so new, it hasn't led to more than a handful of loans for the credit union.

"But people are definitely looking at it, calling the toll-free number, checking the Web site, and talking to car dealers," Meier says. "Not everyone likes to haggle over prices-and you wonder sometimes if you're getting the best bargain. This no-hassle way to help members seemed like a good fit for our membership. This service saves members time and money, and helps them buy cars. Plus, we need to be out there on the Internet and let members and potential members know we have information available."

Competing with the captives

Although it's impossible for credit unions to match new-car loan rates as low as 0.9%, credit unions are finding creative ways to add value to and differentiate their auto loans. Baxter Credit Union's auto equity loan, for example, ties the car to a lien on the member's home, which lets members deduct the interest from their taxes.

Block says the product appeals most to people who have excellent credit and know how to use it wisely. "This is for members who want the car first and foremost but who don't want to wait 10 days to two weeks for a home equity loan. Also, they don't want to amortize their car over a long period of time."

Because members don't want to wait for their right of rescission, the credit union books the loan as a car loan first, using the car as collateral, and then turns it into an auto equity loan. The interest rate is the same as an auto loan, but there's a $100 fee to cover the cost of recording a mortgage. There's no appraisal because the primary collateral is the vehicle. Members can remove the auto equity status at any time and have it revert to an auto loan.