Catching the Wave: The Impact of Direct Lending on Auto Finance

The wave of direct lending is starting to swell, and lenders are working to initiate their programs before it crests.

“[Direct lending] is still small for us, and we’re looking at trying to stay in front of the fact that consumers’ expectations around, predominantly, information is evolving,” Jeffrey Danford, Ally Financial’s senior vice president of auto finance, told Auto Finance News. “We want to stay abreast of that.”

It’s better for lenders to invest, test, and learn from direct lending than be left behind on a consumer demand that is anticipated to take off within the next decade. It would be wise for lenders to dive into these waters early on.

“If you look at the long-term — about 10 years out — direct lending in some form will increase,” Danford added. “Consumers’ expectations of direct engagement with institutions across all industries is increasing. Call it the Amazon effect. Consumers are hungry for 24/7 transactional access. It’s logical to assume that consumers’ desire for digital engagement drives [direct lending].”

That desire for digital engagement extends to finance transactions, too. “Consumers are using mobile apps to access [financing] information, and that’s the way they expect to be interacted with, as well,” Jerry Bowen, executive vice president at Wells Fargo Auto, said during a panel discussion at the Auto Finance Summit 2018.

At only 2% to 3% of a lender’s portfolio, there are long-term reasons why investing in direct lending is more valuable to lenders than the amount of money it generates today.

The Ripple Effect

The importance of direct lending is becoming evident as top players in the industry have increasingly invested in direct-to-consumer platforms within the past year. Chase Auto introduced Chase Auto Direct, and Ally Financial debuted Clearlane. Subprime lender Westlake Financial Services is working on a direct lending portal, too, to be called Loan Center.

While many lenders shy away from disclosing specifics of their direct lending originations, OneMain Financial discussed its platform’s growth during its second-quarter earnings call. OneMain grew its direct auto portfolio 35% year over year, to $3.4 billion as of midyear, the company reported.

“[Direct auto] is about 22% of the portfolio this quarter versus around 18% a year ago, so I think we’re getting growth in our direct auto,” Scott Parker, executive vice president and chief financial officer for the lender, said on the call.

Half of the direct loans Bank of America made in the first quarter were originated via the online direct lending portal the bank debuted a year ago, Chief Financial Officer Paul Donofrio said during an earnings call in April. Bank of America declined to provide AFN with more recent details of its direct lending operations.

However, the bank, which started its direct-to-consumer mobile car shopping service alongside Dealertrack in 2017, is working on blurring the lines between direct and indirect models.

“It’s not an either-or situation,” Kal Valakuzhy, vice president and senior product manager at Bank of America, told AFN. “It’s up to the consumer to decide what works for them.”

“In our studies, we don’t see clients saying, ‘We want this way or that.’ Clients are looking for different options,” Valakuzhy added. “What works for one person doesn’t work for another. If a client wants to apply for a loan on the mobile phone or in person at a financial center, we’ll provide that.”

Additionally, the definition of direct lending today is a lot different than what it was several years ago, Valakuzhy said. “Before, a borrower would go into the financial center and apply for the loan on paper and go through basically the same process [as indirect],” he said. “That situation has changed. That’s not how direct lending is anymore.”

Today, consumers can sit in their houses and use their mobile phones to start an auto loan application while looking at the inventory of cars at a local dealership, Valakuzhy said. Once consumers make their selections, they pick up their vehicles from a dealership or wait for them to be delivered.

Lenders have to keep up with these innovations and adapt. Chase Auto sees substantial growth in its direct lending portal, Peter Gasparro, the bank’s managing director of business development and strategy, told AFN.

“There’s an enormous opportunity for the [direct lending] channel to grow. We have a sizable portfolio, but it is still single-digit share,” he said.

For now, Chase Auto proprietary research shows 76% of consumers still want to “kick the tires” and test drive vehicles before buying, while 47% would consider engaging in an end-to-end online car-buying process, Gasparro said.

“As the thought leaders in this industry, we have to ask ourselves this question: ‘Are we truly trying to improve that customer experience, or are we trying to transfer the economics to other players in the ecosystem?’” Gasparro said.

Consumers want to save time, they want transparency, and they want to trust that the transaction process is fulfilling. To that end, lenders better bring the dealer into the conversation and try to understand their economics as well as the fact that they’re a critical part of the customer journey, Gasparro said.

“They’re going to be there for servicing, and they’re going to be there to have the vehicle picked up.” Chase is still testing the impacts of a wide range of innovations from electric vehicles to subscription service models, and of course, it continues to experiment with its direct lending model.

“We’re always testing an experiment, including our direct model,” Gasparro said. “Have we nailed it? Absolutely not. We’re still trying to figure out what the cash and rates are and how to improve the customer experience.”

Transitioning to Digital 

It’s a revolutionary time for auto finance — lenders are staying at the forefront of innovation by experimenting and testing even more ways to dive into technology that meets consumer demand.

Completely direct lender USAA Bank is establishing itself as an innovative competitor with its augmented reality app pilot — a move meant to provide consumers with a holistic approach to the car-buying experience, Renee Horne, vice president of consumer lending experiences, told AFN.

The app allows consumers to scan cars on the road and apply for auto loans from local inventory right on the spot. “There’s plenty of runway for [direct lending], but at the end of the day, it means ceding share on the indirect side,” Horne said. “Ultimately [USAA’s] intent is to help facilitate that process for the member to make sure they go in there with the most insight, education, and full transparency throughout the process.”

The pilot ended November 1, but at press time the company was still evaluating its viability. “We’re curious to see how members respond and if it delivers on what we intend,” Horne said.

Capital One Auto Finance is also planning to incorporate augmented reality technology into its Auto Navigator carbuying platform.

Meanwhile, Clearlane is Ally’s platform to test, learn, and gain insight into changing consumer behaviors and expectations around direct lending. Although Ally does not break down data into direct-versus-indirect lending categories, Clearlane’s originations are a drop in the ocean compared with Ally’s $8.1 billion third-quarter volume.

“Our goal with Clearlane is partly transactional,” Danford said. “Do we care about the portfolio we’re building? Yes, but it’s more focused toward learning, experimentation, and understanding of consumer behavior relative to how that might translate into an overall better experience with the dealer, not eliminating the dealer, but that combined experience for the consumer.”

Clearlane is considering other enhancements, including artificial intelligence and machine learning, to better anticipate consumer loan qualifications, Danford said. Ally is also working closely with dealers to make the platform transcend the labels of direct and indirect.

“Banks can play on both sides of the fence, and it just moves from one side of the business to the other,” David Hollodick, Bank of America’s senior vice president of consumer vehicle lending, told AFN in January. “Maybe banks’ balance sheets aren’t impacted, but how they lend the money changes over time.”

Bank of America reported a $50 billion auto loan portfolio for the third quarter, with 2,700 auto dealers now participating in its digital shopping experience. The bank’s direct lending platform also allows consumers to see live inventory online at 2,000 participating dealerships.

Additionally, Bank of America rolled out digital capabilities across its consumer lending online platform including Erica, a digital assistant that can help with auto loans and other financial products. Last year, the bank became the finance provider for Volvo Cars’ new subscription service.

Wells Fargo Auto is focused on improving the challenges dealers face to build relationships with consumers in the digital age, Bowen said.

“The No. 1 issue dealers raise to me right now is having a relationship with consumers in the digital age, because most dealerships built their business on [in-person] relationships,” Bowen said, noting that in the past consumers would come to the dealership four or five times before finalizing a purchase.

Today, consumers show up to the dealership once. “The dealer understands that he or she has one shot to get it right,” he added. “The consumer comes to the dealership educated and expects a fast and efficient experience. Dealers need to make that experience fast, consistent, accurate, and engaging. Slow is not going to provide a good outcome.”

Captives Adapt to the Amazon Effect

Since captives operate as completely indirect financing models that rely heavily on the dealer, captives have to explore their own ways of tapping into the digital consumer demand.

Today, dealers are typically working with better-educated consumers that may be more knowledgeable than the sales consultants they’re working with, said Jim DeTrude, vice president of sales and marketing at Nissan Motor Acceptance Corp.

“There’s plenty of opportunities for the dealer to get that consumer moving right before they go to the store,” DeTrude said. “The other thing is the data that’s available. We must figure out how to utilize that effectively. How do you proactively work with your dealer and customer while having access to that data to make a difference?”

NMAC has no intentions of abandoning its dealer distribution network and indirect lender business model, NMAC’s President Kevin Cullum, told AFN. “The only direct lending we do is on a commercial B2B basis and primarily directed at automotive retailers.”

As a captive lender, NMAC relies on its dealers as a source of retail and lease contracts. “We will be offering the opportunity for consumers to apply directly to us for pre-approval of credit and vehicle purchase, financing, and contracting through Nissan and Infiniti dealer websites.”

Toyota Financial Services also has no intentions of disrupting its traditional model of indirect lending. However, that strategy doesn’t stop the captive from enhancing its technology to provide the consumer with options.

“Dealers want TFS part of this equation, and we still have to work together to figure out a little better what that new shared responsibility in retail spaces are as we go,” said Matthew Heydon, group manager of retail transformation at TFS.

The captive is testing pilots that include the dealer, said Sabreen Dhillion, senior manager of relationship marketing at TFS. “Whether it’s rideshare, whether it’s carshare, or short-term rentals, the dealer is a part of the equation in all of those,” she said.

One of the newest pilots is TFS’ Lexus Complete Lease program, slated to launch in the first quarter of 2019. The program is one of nearly half a dozen pilot programs the OEM has started, including Flexible Lease through Uber, Car Sharing pilot in partnership with GetAround, and short-term lease pilot though Launch Mobility.

As the industry moves from a retail process that was manual in many dealerships to one where the transactions for consumers will take place at home, it’s important for lenders to understand that finding the right solutions won’t be a crystal-clear process.

“As an industry, we see and know where [technology] is heading, but the path will be messy along the way,” DeTrude said. “Technology is volatile. Not in a negative way — it’s exciting.”

Editor’s note: This story was originally featured in the November 2018 edition of Auto Finance News’ digital magazine, out now.