Syncing Paths: Where Traditional and Online Lending Meet

Not many companies offer a direct-to consumer product. You wouldn’t go to Crest store to get your toothpaste, a Yoplait store to get your yogurt, and a separate Kleenex store to get your tissues. No, you’d go to a grocery or convenience store and get all of those things in one place.

For the majority of auto finance transactions, the same principle applies — a dealership facilitates the financing of a deal on behalf of all its bank, financial groups, and captive partners. Otherwise, consumers would go to their banks knowing exactly the car they want and arrange financing through what is called a direct deal.

Historically, that distinction was pretty clear. But the Internet changed everything…

“Direct and indirect; those are somewhat technical terms,” Tim Russi, Ally Financial’s president, told Auto Finance News. “As you do business online, those technicalities could diminish as those models appear to converge. If you look way out, the models are very similar.”

If someone uses startup Carvana’s internal financing to purchase a dealer’s car through Carvana’s app, is that a direct deal? If consumers turn to the online NextGen dealership Vroom, which has its own inventory of cars but partners with outside banks for financing, is that an indirect deal?

If the credit union aggregator CU Direct services an auto loan through GrooveCar, how do we classify that transaction?

As these models converge, it may not matter, said Serge Vartanov, chief marketing officer at Auto Gravity — which provides online loans and leases through dealer and captive partners.

“For the customer, the nuance between direct and indirect financing is subtle,” he told AFN. “That peace of mind of seeing your financing options, being able to select a rate and lender that’s right for you, and being able to see your monthly payment before you go to the dealership is fantastic. That’s what customers are looking for.”

While it may make little difference to the consumer, dealers are concerned third parties may insert themselves into the value chain at the expense of dealerships, said Karen Ideno, vice president of product and marketing at Toyota Financial Services, in a statement.

“The current complexity of the car-buying process runs contrary to what consumers expect and are looking for, with auto finance being a key enabler in this process,” Ideno said. “The auto industry needs to continue to embrace the technology that allows us to marry the digital and physical worlds to create a differentiated and superior guest experience.”

Online auto financing is a highly fragmented market today, and whether it’s indirect, direct, or some hybrid method, “the winner at the end of the day is the best customer experience,” Vartanov said.

DIRECT FINANCING

Perhaps the purest form of an online direct-to-consumer model on the market comes from Tesla Motors. The luxury OEM offers online leasing through its own website, select dealership locations, and financial arm, which is growing fast. Lease volume has more than quadrupled for the company year over year, according to the company’s third quarter earnings, but outside financing offers are also allowed.

“Really, it’s about the consumer experience,” said Tesla Chief Financial Officer Jason Wheeler during the company’s earnings call. “If we can use other folks’ capital for that, great. If we use our capital for it, that’s fine too, and we’re willing to make those decisions.”

Direct financing is an attractive concept because it means there’s no splitting the profits with a dealer partner. However, that also means there’s no splitting the responsibilities, said Daniel Yuabov, chief of operations at the 2016 startup Carvoy, which offers online leasing through dealerships.

“There are a lot of different variables such as fraud — and repossessions — that the dealerships have better tendencies in picking out,” Yuabov told AFN. “We give dealerships the control of verifying the deal, verifying the credit information, and all that fun stuff. Because once we come into play doing that, we may be more liable and create more issues for us in the long run.”

Despite those hurdles, there are certainly companies interested in servicing direct deals. In August, JP Morgan Chase launched Chase Auto Direct, which works with TrueCar’s technology to provide financing and servicing through Chase’s network of 14,000 dealers. Ally Financial is also dipping its toes in direct financing with the purchase of BlueYield in October.

“As we went to launch a direct product, often times you don’t have systems,” Ally’s Russi said. “So we went out to look for the technology enablers that we thought best in class at what we were looking to do with our direct lending model. And that’s how we found BlueYield. We’re very excited about the evolution of that business model as we intend to innovate it going forward.”

It may be too early to tell yet if the direct model will have a huge impact on the industry, but that doesn’t mean new entrants won’t try, said Nathan Hecht, chief executive of the indirect digital lending platform Honcker.

“The direct model has the potential to work if the captives are willing to make the necessary investments that need to be made for consumers to feel serviced,” Hecht said. “I’m a proponent of the direct model at the same time as I’m a proponent of the dealership simply because there is room for both.”

But there isn’t much consumer demand for this kind of all-in-one direct model, Toyota Financial’s Ideno said.

“They are asking, ‘Can I afford this? Am I going to get the quality of service I expect?’” Ideno said. “Captives help drive customer loyalty by bringing customers back to the dealerships, back to the brand; which may not always be a priority for direct lenders.”

One of the only captives investing in online direct lending is overseas through Hyundai UK. The program called “Click to Buy” offers an online portal where financing is all done online but the contracts have to be signed in a dealership, said Hyundai UK’s President and Chief Executive Tony Whitehorn.

“What we have done with our Click to Buy is directing them back [to the dealership] to have the car handed over,” Whitehorn said. “Our research has said that the customer wants to have an ongoing relationship; and that relationship needs to have some degree of permanency.”

INDIRECT FINANCING

Indirect channels are by far the most prominent method of financing.  Most companies don’t separate direct from indirect volume, and neither Black Book nor Experian were able to provide AFN with individualized origination numbers.

However, Wells Fargo Dealer Services — one of the top five auto lenders in the country — does separate its originations by direct and indirect, and it shows a heavy leaning towards dealerships. Direct lending only made up 4.6% of its $62.9 billion auto outstandings, according to the company’s third-quarter earnings.

There’s a simple reason why indirect is heavily favored, said Aite Group’s Senior Analyst Christine Pratt. “Dealers have the cars; they win.”

The majority of fintechs seek out partnerships with large dealer groups, since they have both the inventory and the lending partners built in, said Colleen Poynton, vice president of Core Innovation Capital, which helps develop young financial startups.

“It’s a digital indirect, but the difference is that instead of an F&I agent being the one running that process, it’s the consumers who are walking themselves through it on a Saturday afternoon in their kitchen,” Poynton said. “[Direct financing] will probably still be a smaller source of volume than the channel where the asset transaction is occurring. Historically that’s been the dealer floor. And more and more, I think that will be digital.”

While Honcker’s Hecht believes direct and indirect models can both exist in the industry, ultimately his platform opted to work with the dealers because of the value they add.

“The dealer lobby is incredibly strong, and dealerships offer tremendous value to the consumer,” Hecht said. “Yes, it’s not always the smoothest transaction with the dealer. Yes, not everyone likes negotiating with the dealer. But there is still a lot of value that the dealer brings.”

Favoring the dealership model is also a matter of recognizing that all consumers won’t want to shop online, and whether they are learning about the F&I process through a salesperson or an online app, consumers want to feel they’ve made an informed purchase, AutoGravity’s Vartanov said.

“There are consumers that don’t feel as sophisticated and confident when it comes to having conversations around financing,” Vartanov said. “For consumers to have peace of mind they need to feel confident, educated, and aware as they go through the financing journey.”

So, will direct lending come to impact the dominance of indirect?

“Never,” Pratt said. “Not until that love affair with consumers and the automobile ends, and I don’t see that happening anytime soon.”