Same players, new tricks: Exploring the subtle art of direct lending

Roughly two years ago, direct-to-consumer lending gained traction as top industry players Ally Financial, Bank of America and Chase Auto launched online lending platforms. Since then, smaller financiers have trickled onto the direct lending playing field and are now grappling with the need to facilitate an online platform while scaling their business.

As consumers put pressure on the industry to offer online financing options, lenders are shifting strategies to bolster direct lending volumes. In fact, subprime lenders Consumer Portfolio Services and Westlake Financial Services have ramped up their online lending portals, while Global Lending Services is drawing up plans for its direct lending business, a move Chief Executive Steve Thibodeau called “the next gear of [the company’s] growth engine.”

However, developing a direct lending platform is no small feat. As lenders conceptualize their direct-to-consumer businesses, they must overcome a number of hurdles, including synergy between their indirect and direct platforms, coordination with dealer partners and providing omnichannel communication for consumers.

Another challenge for lenders is standing out in a crowded field. According to CPS Vice President of Sales Curt Powell, “customers get bombarded with credit offers — both real and exaggerated — once they submit an application online.”

Striking a balance between indirect and direct lending platforms can find some lenders narrowing their focus. At the beginning of 2019, Birmingham, Ala.-based Regions Bank shuttered its indirect auto lending business, choosing instead to only originate direct loans.

For CPS, the consolidation strategy entails refining its dealer network to grow its direct lending business, Powell said. The Irvine, Calif.- based lender originated $8.2 million of direct loans in the first quarter of 2019, and boasts a $2.4 billion total portfolio. “The first thing we’re going to do is focus on a more narrow group of dealers that we do [direct] business with,” Powell said. “There are some very good dealers we use on a repeated basis that are thrilled we are bringing them a ready-to-go deal and they follow the program.”

The next step will be to work on geotargeting in the specific markets where dealers follow the direct lending program, Powell said. “We want to [improve] geotargeting through advertising and marketing campaigns,” he said. “Take Los Angeles for example: If we have five or six dealers in that market, then we can really push [direct lending] business development in that area.”

Avoiding the ‘flip’

The success of direct lending programs can come down to dealer adoption. “The problem is that a lot of consumers aren’t sure if they are getting a better loan offer from the lender or dealer,” Powell noted. “Consumers tend to follow the advice of the dealer because the dealer is the one that has the inventory.”

Cue the inevitable “dealer flipping” issue.

“A car buyer might secure a loan preapproval before car shopping, but then opt to take dealer financing in the F&I office,” noted Outside Financial’s Chief Executive Sonia Steinway. “Sometimes, that’s the best option for that buyer — no direct lender can compete with 0% subvented rates from a captive finance company.”

But there are times a car buyer “flips” because the dealer does a great job persuading him to accept a worse deal, Steinway said. “For example, taking out a loan with a 96-month term so that the monthly payment is lower or agreeing to a loan with a lower APR but then buying products with huge markups,” she explained.

While lenders grapple to find a solution to flipping, Steinway zeroes in on empowering car buyers to calculate which loan offer is best for them. On top of that, it’s about catering to the dealer, and “making the loan funding process as easy and quick as possible to minimize the dealer’s desire to flip the customer,” she said.

As companies refine their strategies to boost direct lending volume, they will have to find the synergy between indirect and direct, Powell noted. To that end, smaller-scale lenders are pushing for a robust online inventory to solve the dealer “flip” issue. “We need to tie in dealer inventory in some way, so our program is a ‘full service’ process for the customer — vehicles and financing,” Powell added.

Enter Carvana, which fulfills both the lender and dealer role for consumers and facilitates the full transaction online. CPS has partnered with Carvana to add inventory options for consumers when they receive a direct loan from CPS. “Carvana’s got 75,000 cars [in its inventory],” Powell said. “If we could have a huge dealer inventory in each market we work in — we’d be in good shape.”

The potential growth of direct lending is evident in Carvana’s volume. Originations hit $1.9 billion, a 115% year-over-year increase in the third quarter of 2019, according to the company’s most recent earnings report. Further, Carvana sold 46,413 retail units, up 83% from the prior-year period.

Bank of America, too, partnered with Carvana last year to add 15,000 vehicles to its digital car shopping and financing platform. Since then, the bank’s direct-to-consumer online portal accounted for 56% of direct auto loan originations, Chief Financial Officer Paul Donofrio said during the bank’s fourth-quarter earnings call last month.

Getting from prequalification to funded contract can be difficult for many direct lenders because of the coordination required between the lender, customer and dealer, much of which the customer is responsible for managing, Christina Keiser, Carvana’s senior director of strategic partnerships, told Auto Finance News. “Because Carvana is both lender and dealer, we avoid this three-party coordination issue and can combine prequalification, vehicle selection, underwriting, and contracting into one flow,” she added.

Westlake Vice President of Services Ralph Ontiveros has a similar strategy to add more dealer inventory to the direct financing program. Los Angeles-based Westlake — whose total portfolio hit $8 billion last year — started prioritizing a diverse dealer inventory for its direct lending platform in hopes that more vehicle options for consumers will drive higher origination volume.

USAA Bank leverages its car-buying service to give members access to inventory from more than 17,000 new and used vehicle dealers nationwide, Vice President of Consumer Lending Experiences Renee Horne told AFN. “We are able to provide access to our members wherever they are, and they can shop where they choose with an approved financing offer,” she said. “In addition, the loan process is fully enabled on digital, and members can choose to use their mobile app to engage USAA or speak to a member service representative to provide assistance.”

Yet, increasing vehicle inventory is just one piece of the direct lending puzzle.

Establishing a dialogue

When a lender interacts directly with a borrower to secure financing — as opposed to using a dealer as an intermediary — it has control over the customer experience and how the brand is received.

“A customer may not know or remember whether their loan was direct,” Carvana’s Keiser said. “They will, however, know if they enjoyed the experience — the rate, the transparency, the convenience of the process. I’d suggest that lenders invest in making the customer experience as good as, or better than, indirect lending if they hope to grow their direct lending platforms.”

For CPS, the challenge is establishing a dialogue after a customer has been approved. About half of customers approved for financing via its direct platform do not respond to notices, which is “super surprising” given the subprime universe, Powell said. “It’s a real head-scratcher for us,” he added. “We reach out to all approved customers via text, email and phone.”

In an effort to empower consumers, CPS will also place its focus on improving its online customer experience. “This really boils down to simplifying our message and process and improving customer access to loan status online — rather than forcing a phone call,” Powell said.

“People don’t want to read anymore, so we are working on doing a better job of expressing our message through icons and graphics,” he shared. “What we want to do is have more symbols — for example, green checks and red X’s to visualize the steps of the process, as opposed to the consumer having to read something.”

Providing a streamlined online channel is vital to having repeat business. In fact, CPS’s default and loss rates on direct lending are trending a “bit better” than its indirect program, Powell noted. “The trend is attributable to lower loan-to-value, lower payment-to-income and the customer not being jammed into a vehicle they don’t really like,” Powell said. “The customer is more in charge of the entire purchase process — which makes them feel empowered, to some degree.”

While auto financiers invest, test and learn from direct lending, USAA Bank, for one, has established a $15.6 billion auto book with loans completely secured via the San Antonio-based lender’s digital process.

“The digital experience is a journey that encompasses the entire process, from acquisition to service,” USAA’s Horne said. “We offer our members flexible products and competitive pricing and equip them before entering a dealership with approved loan terms and guidance,” she said.

In addition, USAA helps consumers avoid overextending longer-term loans to ensure customers are making smart financial decisions based on their needs. Still, even USAA recognizes that the majority of the industry is still indirect, enabling broader exposure at the dealer due to reach provided by dealer networks, Horne added.

“Direct lending is very relevant for a niche market like ours, but I imagine it can limit opportunities to provide financing at the point of sale for more general market consumer banks or even create channel conflicts for those who have large indirect books of business,” Horne said.

Editor’s note: This story was originally featured in the February issue of Auto Finance News magazine, out now.