OCC warns against lax auto loan standards
The U.S. auto industry is booming. According to Federal Reserve Economic Data (FRED), total light weight vehicle sales rose to 16.6 million in January 2015, from 15.2 million the year prior. Unsurprisingly, the sales growth also increased demand for auto loans at domestic banks. FRED reports that 25.4 percent of banks reported stronger demand for auto loans in Q4 of 2014, up from 18.8 percent in Q4 of 2013.
Demand is also increasing at credit unions. Credit union auto loan portfolios reached $225 billion as of the end of Q3 2014, according to Sageworks Bank Information. This is up from $193 billion as of Q3 2013, and $173 billion the year prior. As a result, competition among banks and credit unions is intensifying. To continue growth in their portfolios and keep pace with credit unions, many U.S. banks are lowering underwriting standards. Recent comments from Darrin Benhart, deputy comptroller for supervision risk at the OCC, highlighted the OCC’s concerns about the evolution of the auto loan market and the risks that are being taken.
Speaking at the Global Association of Risk Professionals 16th Annual Risk Management Conference, Benhart noted, “Competition and the reach for revenue and yield has lowered underwriting standards and introduced new product features that may adversely affect the performance of these loans over time.” Here are some of the key changes highlighted in his speech:
• According to Experian, the share of 73- to 84-month loans for new cars increased to 24 percent, up from 12 percent two years prior.
• Long-term loans for used cars also doubled to 14 percent over the same time period
• Borrowers with lower overall credit scores are being approved
• Loans are being made with higher loan-to-value (LTV) ratios
• Average dollar losses per vehicle are rising
These changes were first reported in the OCC’s Semiannual Risk Perspective for Fall 2014. The document stated that since delinquency and loss rates are expressed as a percent of volume, the rapid growth in volume has offset the full impact of the risks. “Banks that followed the competitive industry trends to longer terms and higher LTVs face increasing risk in their auto loan portfolios should collateral values collapse.”
The tools used by banks to underwrite loans and qualify borrowers are also changing, according to Benhart. He noted that credit ratings often ignore or downplay the potential impact of certain debt. “While the changes in the ratings may be warranted, banks must understand what these changes mean relative to evaluating a borrower’s total ability to manage new debt.” Credit ratings are certainly still a valuable assessment tool, but banks should evaluate other ways to get a more comprehensive picture of a borrower and their “ability and willingness to repay in a timely fashion.”
Benhart also highlighted the combination of weaker underwriting of low rates, higher LTVs, bundling add-on products (such as extended auto warranties) and longer loan terms as contributing to borrowers’ focus on payment affordability instead of long-term sustainability. “When the borrower experiences difficulties, they are more likely to default and the loss will likely be greater for the lender and investors.”
The OCC often promotes the need for a healthy risk culture. Implementing one would certainly help mitigate the concerns referenced above. Benhart referenced a recent quote from Thomas Curry, comptroller of the currency, which stated, “[s]ound risk management, supported by a healthy organizational culture, aims at protecting the bank’s reputation and shelters it from credit losses, litigation risk, and the kind of breakdowns in operational risk that, as we have seen, can have very significant consequences.”
For more on how to create the right credit risk culture at your bank, access this complimentary, on-demand webinar: Instilling the Right Credit Risk Culture.