BEDFORD, Texas—Auto loan debt owned by U.S. households topped $1 trillion for the first time during 2015—and in the same year the average length of auto loans hit an all-time high of 67 months.
That the auto lending business is booming is no secret to credit unions, driven by low interest rates, cheap gas, and consumer demand for the latest in cars and trucks. But at the same time concern is growing over increasing risk, State National reports.
An increasing number of borrowers have been overextending and heading into negative equity more often, and that is lengthening the period before the loan balance and car’s value break even, said John M. Pearson, EVP of sales at State National.
And while the auto lending resurgence has been a large driver of credit union growth, Pearson cautions that lenders need to raise their risk radar.
Longer Terms
“The percentage of loans with terms of 73 to 84 months reached a new record of nearly 30%, up over five percentage points from the prior year,” said Pearson. “Long-term used vehicle loans spiked as well, with loan terms of 73 to 84 months reaching 16%.”
In the past year a number of analysts have questioned whether lenders and borrowers are starting to forget the past and some of the issues that contributed to the economic meltdown.
Regulators are concerned, as well, noted Pearson. In its Fall 2015 Semiannual Risk Perspective, the OCC detailed its focus on how banks with auto portfolios are managing their risk in an era of extended loan terms, higher loan amounts, increased new and used car values, and higher loan-to-value levels.
John Pearson
“The OCC noted that longer terms and higher values put borrowers in a negative equity position and lengthened the time before a break-even point is reached on a loan,” Pearson said. “Higher vehicle prices, particularly higher-than-average values on used cars, puts lenders at risk if the market turns and values drop. The OCC is also concerned about lax underwriting standards, particularly among lenders with high concentrations of auto loans and in leveraged lending with indirect auto.”
As several reports indicated in 2015, subprime auto lending is also growing. Through September 2015, more than $110 billion of loans were originated to borrowers with credit scores below 660, and $70 billion to borrowers with credit scores under 620, Pearson said.
“Long-term loans combined with lax standards creates risk for lenders by increasing the likelihood of negative equity on default,” he said. “A longer time to break even also increases the loss exposure if a borrower defaults. With loan values up and terms extended, more consumers will be upside-down on their existing loan, and upside-down borrowers are more likely to attempt to walk or skip, leading to repossession.”
Collateral Protection
Unfortunately for credit unions as well as for banks, most repossessed vehicles will have unrepaired damage, and the cost of repairs continues to escalate, said Pearson, adding that lenders also incur thousands of dollars of indirect costs involved with storing, handling, and processing of repossessed vehicles.
“Collateral protection insurance (CPI) enables lenders to transfer the risk of uninsured collateral to an insurer,” said Pearson. “CPI pays lenders for damage to vehicles they repossess whether or not they make repairs before the vehicles are remarketed, and some programs can also provide ancillary coverage for other costs of repossession.”
In addition to providing collateral protection, a secure, compliant CPI provider also delivers a level of assurance to regulators, asserted Pearson.
“CPI is the smartest choice lenders can make to manage risk associated with today’s lending climate,” he said.