BY EMILY HOLLIS
Is your credit union really making money on indirect loans? The answer to that question isn’t as simple as it might seem. The true realized yield of such loans is more complex than you might imagine. See how a loan profitability analysis can sort it all out.
Results from our loan analyses are sometimes surprising to clients. It is not abnormal to show higher occurrences of negative yields in “A” paper, versus “B” and “C,” which is somewhat counter intuitive. In many cases, higher-quality indirect paper is just priced too low. In order to assess whether indirect loan programs are profitable, analysis incorporating dealer fees and the risk of prepayments is essential.
A loan profitability analysis can ascertain whether a financial institution is truly making money on indirect loans. Profitability is measured as a net yield over the life of the loan, which includes historical results as well as projected.
For car loans in general, poor performance can be masked by seasonality or growth. And loan analyses that just show monthly net yields can be very misleading. Defaults and delinquencies are dependent upon not only the credit criteria of the loans but also their seasonality. Normally defaults and delinquencies can be represented by a “bell curve.” In other words, within a portfolio of loans, loans that have a few months to mature tend to experience minimal defaults while those in the 18- to 30-month range normally show the maximum losses of a particular pool. For indirect loans, determining the realized yield is more complex thanks to the indirect fees, which must be written off due to prepayments or defaults.