One interesting item I found tucked away in my notebook was a reference to the behavior of "A" paper originated via indirect channels. According to Emily Hollis, ALM First Financial Advisor's President, "A" paper purchased from dealers is typically a loss leader for credit unions - apparently unbeknownst to many of the credit unions engaged in indirect lending.
ALM First offers a loan portfolio analysis service whereby the indirect portfolio is reviewed to determine the true profitability of the overall program as well as the profitability of each risk tier. What they found is that on average most portfolios suffer negative spread on their "A" tier. What are the drivers for this phenomenon? There are two. The first driver is loan prepayment. A much larger portion of "A" borrowers end up prepaying auto loans - especially those obtained via dealer financing. The second driver is the cost of loan acquisition, otherwise known as dealer fees.
Taken individually, each driver may not result in negative spread on "A" paper. When combined, however, you end up with a perfect storm.
Of course using "A" paper as a loss leader of sorts is, in itself, not bad strategy, but only if it is in fact a strategy. Perhaps a credit union is willing to suffer negative spread because they can make up the difference via deeper relationships with these indirect "A" members. Or, perhaps taking these borrowers results in greater dealer volume for more profitable "B" and "C" loans. As Emily noted, however, the prevailing problem is that many credit unions do not know about the negative spread in the "A" tier, which means that it is not a conscious strategy.
I would love to hear from any credit union that actively makes use of a "loss leader" strategy for "A" paper. Is it working? Can active relationships with indirect "A" members be developed to such a degree that negative spread can be overcome?
While feedback on this issue would be great, I'm not so sure I'll be hearing any any time soon!
