how to lower the risk profile of your auto loan portfolio

Enterprise Risk · Credit Risk · Market Risk · Operational Risk · Regulatory Compliance · Securities Lending

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HOW TO LOWER THE RISK PROFILE OF YOUR AUTO LOAN PORTFOLIOTHE RISE OF AGGRESSIVE INDIRECT AUTO UNDERWRITING AND ACTIONS YOU CAN TAKE NOW

FROM THE RMA CREDIT RISK COUNCIL’S2016 INDUSTRY INSIGHTS


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Recent media reports have compared the current status of the auto lending industry to the period

preceding the bust of the housing bubble.

Loosening underwriting standards and thin pricing margins are a recipe for credit stress.

AGGRESSIVE INDIRECT AUTO UNDERWRITING


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SUBSTANTIAL CREDIT LOSS IS BUILDING

While there are several fundamental differences between

auto lending and residential real estate lending,

the potential for substantial credit losses

is building within the indirect auto lending sector.


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EARLY RECESSION REBOUND

Coming out of the recession, auto lending was one the of first asset classes to see credit performance rebound.

A significant factor in the quick rebound was the relatively short duration of the loans.

Compared to mortgages, a portfolio of poorly structured and underwritten auto loans turns over more quickly.


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EARLY RECESSION REBOUND (CONT.)

Tightening throughout the auto lending industry during the height of the housing crisis led to historically low net charge-off rates as early as 2011.

At the same time credit performance was improving, new vehicle sales in the U.S. grew substantially.

Annual new vehicle sales increased for six consecutive years, growing from 10.6 million units in 2009 to 17.8 million units in 2015*.

*wardsauto.com


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AUTO LENDING BECAME A GROWTH ENGINE

Given these market dynamics, auto lending

(specifically indirect auto lending) was identified as

a growth engine for many financial institutions.


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AGGRESSIVE UNDERWRITING FOLLOWED

As financial institutions turned to indirect auto lending for portfolio growth,

aggressive underwriting standards inevitability followed.


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TERM STRUCTURES ARE A CONCERN

Of particular concern to credit risk managers is that term structures (number of months the customer

is given for repayment) began increasing.


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TERM STRUCTURES ARE A CONCERN (CONT.)

In 2015: 29% of loans for new vehicles had extended terms (greater than 72 months).

A 12% increase from the prior year*. * Experian Automotive, "State of the Automotive

Finance Market Fourth Quarter 2015."


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EXTENDED TERM STRUCTURES SHOULD BE CLOSELY MONITORED

Watch for:

Increase in loss given

default due to slower

amortization.

Potential for adverse selection (customer

“backing into a payment”).

Longer recovery time

for the portfolio following a

period of credit stress.


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Place limits on new business allowed within this segment.

Limit risk layering, e.g., high loan-to-value ratios in combination with extended terms.

Enhance ability-to-pay standards (payment to income/ debt to income) to ensure you are not attracting customers that are “backing into a payment.”

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ACTIONS TO CONSIDER FOR EXTENDED TERM STRUCTURES


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MONITOR UNDERWRITING STANDARDS

In a highly competitive, fast growing market, underwriting standards must be monitored

diligently.


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THE BENEFITS OF ACTING NOW

Taking action now can lower the risk profile of your auto loan portfolio

and reduce the likelihood of unnecessary credit stress in the future.


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The Credit Risk Council supports professionals who are responsible for establishing, maintaining, or carrying out credit risk management policies.

The council focuses on funded and off-balance-sheet risk management, including capital markets activity, and other forms of credit intermediation and risk mitigation.

ABOUT RMA’S CREDIT RISK COUNCIL


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Visit http://www.rmahq.org for information on risk management

RMA is a member-driven professional association whose sole purpose is to advance sound risk principles in the financial services industry.

RMA helps its members use sound risk principles to improve institutional performance and financial stability, and enhance the risk competency of individuals through information, education, peer sharing, and networking.

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how to lower the risk profile of your auto loan portfolio

Economy & Finance