So, I admit I was initially puzzled as to why Upstart was focusing so heavily on auto refinance rather than auto purchase lending, especially as they acquired Prodigy earlier this year, which is really about car purchase loans.
Well, I watched an auto lending webinar given by Upstart to prospective bank partners plus reviewed a couple brochures – and it makes sense. Auto refi is the lower hanging fruit for UPST, possibly with better unit economics than auto purchase.
I’d like to share my notes as follows:
Val Gui gives the webinar talk. He is the VP of automotive lending at UPST. He has 10 years of automotive experience, including managing 12 car dealerships that had combined revenue 450 million. Has past hands on experience in a startup, was cofounder/COO of instamotor (which focused on auto financing).
Banks struggle to build a large profitable portfolio of auto loans, although the market is massive.
Building a robust auto loan segment helps with adapting to the current environment of:
-Record cash deposit levels
-Demand for loans overall was falling due to stimulus
-Branch traffic is down, exacerbated by COVID
-Low interest/low yield environment
-Accelerated consumer demand and acceptance of digital interaction
There are two auto lending segments of opportunity with current trends/macro environment. Auto refinance, and auto-loan origination
There are over 1.37T outstanding auto loans. (It’s actually 1.42T as of the latest Fed report)
Auto refi comprised 4.5% of auto loans in 2019 (1.2 million transactions) vs 95.5% new auto loan accounts (25.1 million transactions).
Auto refinancing has not been well explored as a growth channel, despite the following benefits:
- easier to find/market to consumers who have existing auto loans, as it’s much more difficult to find the consumer who is seriously in the market to buy a vehicle,
- less risk to lender as consumers have a track record of making payments on existing loan,
- cross-sell opportunities available when you save the consumer money with refi and establish trust.
Val Gui gave a webinar poll to the banking audience:
47% say they offer autorefi but it’s adhoc/not significant (just a product of convenience).
29.4% don’t offer but would like to.
23.5% market it and it’s a meaningful part of portfolio.
Why is auto refi difficult? Barriers to entry:
lien perfection increases transaction costs,
smaller loan sizes make unit economics unprofitable,
and the entire process can be complicated for consumers who might need to make trips to DMV, notary, etc.
Well, the angle of attack to this is just like with personal loans:
- lower the rates to reflect true risk as many loans are overpriced, and 2) make it a frictionless customer experience.
Digital innovation drives greater efficiencies (Savings on DMV registration, titling costs etc that typically eat into margin)
Upstart’s AI/ML models reduce marketing costs by knowing which borrower to target, lowers friction with instant verification, and lowering loan rates.
Upstart can also service the loans by identifying at risk borrowers and proactively outreach to those at risk/manage potential losses.
The crux of this, as usual, is the ability to reduce rates without increasing defaults, as consumers want to reduce monthly payment expenses. That is their primary focus.
TransUnion reported that of consumers who refinanced, 86% saved over $10.
This indicates a willingness for consumers to lessen monthly expenses, even if the amount is as low as $10.
The report added that many refinanced for less than $30, underscoring these were not edge cases.
This was confirmed with Upstart’s studies which found that:
27.5% of auto loan borrowers can save over $20/month.
12.2% can save 0-$19/month.
60.3% likely have no auto-refi opportunity given their existing loan APR is not mispriced enough.
(Keep in mind, these refi offers are with keeping the SAME loan term and not extending loan duration, so it actually saves the borrower money overall - unlike other predatory refi companies.)
Upstart has found that $20/month savings is the threshold where borrowers generally find it meaningful enough to accept auto-refi.
Some do accept auto refi savings of less than $20/month, but not as many.
However, marketing dollars should be targeted to those who are most likely to accept (the $20+/month savings group).
This means there is a massive opportunity to grow from today’s 4.5% refi share of auto loans into a share of 27.5% (expand the market by a multiple of 6).
27.5% of 1.4 trillion outstanding auto loans = 385 billion auto refi opportunity.
Assume $20,000 average loan size, and that’s 19.25 million consumers to target.
Moving onto auto loan origination (purchase auto lending):
There are over $600B in auto loan originations annually.
35% of auto loans are direct purchase, which are profitable but hard to grow.
This is where customers go directly to the bank/branch to get a loan, and then go to the dealership with that financing. But dealerships can flip that loan away from the consumer who physically walks through the door, by offering a different deal.
65% of auto loans are indirect purchase. These are so heavily competed, there are only razor thin margins.
This is where the consumer goes to the dealership without financing arranged. Then, the dealers are acting as an intermediary by offering loan options from its banking partners. The dealer ultimately decides if that consumer is provided your loan for financing or some other bank.
What you need to win in purchase auto lending:
-instant pricing for all applicants
-Pricing/approval via soft credit pull
-Instant offer re-evaluation for multiple vehicles/multiple structures
-True per offer, risk based approvals and pricing
Like with auto-refi, Upstart’s platform offers all of the above.
Upstart’s Prodigy can also help benefit the dealer, bank, and consumer:
allows dealer to interact with consumer on their own terms,
allows consumer to shop online/offline,
allows the bank to compete directly via loans offered on platform
Webinar and brochures: