Managing Risk in Indirect Auto Portfolios

The following is the next installment in RMA’s Credit Risk Council 2017 Industry Insights: Perspectives from the Front Line.

Recent finance industry media coverage has shown concern over the impact of new car volumes on resale prices, and concurrent competitive pressure on vehicle loan pricing. With new car sales growing every year from 2009 (10.4 million units) to 20161 (17.5 million units), there have also been more aggressive pricing strategies and less restrictive underwriting standards throughout the industry. The expectation from the media is that sometime over the next year new vehicle sales will plateau and credit performance will begin to deteriorate.

Over the past two years, lenders have:

  • Priced new originations more aggressively. During 2016, the average APR on new loans declined to 6.15%, compared to 6.32% in 20152. These price decreases were seen throughout the credit spectrum.
  • Offered longer term loans. Industry average term has grown to over five years (68 months)3. During Q4 2016, 32% of originations for new vehicle loans had terms greater than 72 months, compared with 29% in Q4 20153.
  • Enabled greater negative equity on trade-in. In 2016, 32% of loans included a payoff of a prior loan compared to 29% in 20152.
  • Increased subprime (low FICO Score) lending. In 2016, 23% of industry loans were originated to subprime customers, continuing a trend that has led to subprime loan balances increasing each of the past three years, comprising 20% of total outstanding auto loans in 20163.

The combination of a rising interest rate environment, the potential oversupply of used vehicles, and increased lending to marginal borrowers with lower credit scores is expected to lead to a deterioration of credit performance within the next 18 months. Several steps can be taken in advance of this expected deterioration to potentially minimize performance degradation within an indirect auto portfolio. Examples include: 

  • Closely monitor advance rates and establish decreasing maximum advance limits as borrower credit quality moves downward throughout the risk score spectrum or up in term to avoid layering risk.
  • Establish origination and portfolio receivable limits on high risk categories to ensure a risk diversified portfolio.
  • Lower maximum allowable advance rates as borrowers seek extended terms.
  • Reduce negative equity (underwater trade-in) loans or minimize the dollars involved.

Additional effort should be made to manage prior marginal originations more closely in account/portfolio management. Techniques to manage these include more frequent validation and verification of customer data, and periodically assuring validity of email addresses, phone and cell phone numbers and customer addresses, even for non-delinquent customers. It is also recommended to monitor the portfolio for multiple payments per month, a sign of customers living closer to their paycheck. 

These customer and exposure management techniques for marginal loans should be added to existing methods of update, including earlier repossession of assets and more frequent updating of non-loan holder credit data (more frequent bureau updates).

In a highly competitive, fast-growing market, underwriting standards must be monitored closely.  Greater action now can lower the risk profile of your auto loan portfolio and reduce the likelihood of unnecessary credit stress in the future.

1 autonews.com

2 JD Power Information Network

3 Experian State of the Auto Finance Market – Q4 2016

Please look for the next Industry Insight on Tuesday, August 22, Being a Banker Today – The Changing Role of the Underwriter.

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