What do I have and where is it going?
The “noise” in the auto lending arena has risen to the level of driving down the road at 70 miles per hour with all the windows down. Total auto loans have crossed the $1 trillion thresholds, joining credit cards and student loans at that level. Delinquencies on subprime loans (an area of which most credit unions steered clear) are on the rise. Auction prices on used cars are dropping. And every indication is that rates will continue to increase, squeezing the yield on existing portfolios and dampening future volumes.
All this noise is causing credit union lenders to ask: What do I have in my auto portfolio, and where is it going?
What do I have?
There are several tools you can deploy to determine what is in your existing portfolio and if it is performing acceptably. Two key tools are described below.
Risk-based Lending Revalidation – A revalidation of your risk-based lending pricing model will calculate your net yield in each category of your auto loans. This analysis is akin to creating an income statement for each credit tier within each of your loan types. The analysis factors in all costs, from your cost of funds to your net charge-offs. As a result, you’ll be able to determine what each credit tier on each product is contributing to your bottom line. This analysis will help you home in on those tiers in which defaults may be driving the yield down, or in which market rate competition has driven yields below desired levels. While many credit unions look at the risk-based lending process as meeting regulatory requirements, others see the business relevance of understanding how the different portions of their portfolio are performing.
Static Pool Analysis – The Static Pool Analysis (SPA) is a valuable tool to isolate vintages of loans and determine how those vintages have performed since origination. Vintages are most typically defined by timeframe (e.g. quarter or year of origination), but can also be defined by other factors such as dealer group. The SPA eliminates the noise from the ins and outs of portfolio activity that can distort the true performance illustrated in other analyses. This analysis will help determine the number of factors, such as whether a particular period of originations could benefit from increased collections attention, or if a particular dealer group is driving your performance in one direction or the other.
Where is it going?
Crunching the numbers on your existing portfolio can also illuminate your route going forward. With a slight twist, one of the tools described above can be leveraged to calculate the impact of future changes.
Risk-based Lending Revalidation with Forecasts – While similar to the revalidation summarized above, the twist with the forecast is that key variables are modified based on a variety of scenarios. For example, you may want to calculate the impact of future rate increases, thereby increasing both the cost of funds and the gross interest rate. Or you may want to assume that net charge-offs increase by a certain percentage. These changes in forecasts, in part and in total, will estimate the net yield on each credit tier on each product. This may be just the information you need to determine if competition in the prime and super-prime sectors has become too frothy to continue competing in this arena. As Richard J. Parsons notes in his equity analysis of banks lending to the same prime and super-prime borrowers most credit unions lend to, “While these banks are highly unlikely to experience a spike in bad auto loans because of their client selection strategy, they still must remain disciplined to get adequate pricing (yield)…”
Given the many changes and uncertainties in this environment, it is imperative that you fully understand where your portfolio is and where it’s going. This knowledge will help your credit union assess actions to take today to improve the performance of your existing loan portfolio and position the credit union to continue to excel as it writes new loans. These tools will help you to determine whether you can put the pedal-to-the-medal, or if it’s time to “tap the brakes” on portions of your auto lending.