Recent loosening of underwriting standards and thin pricing margins in the indirect auto lending sector have increased credit risk, similar to the build up before the housing crisis. While auto loans have shorter durations than mortgages, leading to quicker recoveries after past recessions, extended loan terms now pose risks like higher defaults and slower portfolio improvements during downturns. Risk managers should closely monitor underwriting practices like debt-to-income ratios and place limits on high-risk loans terms to reduce future credit losses.

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HOW TO LOWER THE RISK PROFILE
OF YOUR AUTO LOAN PORTFOLIO
THE RISE OF AGGRESSIVE INDIRECT
AUTO UNDERWRITING AND ACTIONS YOU
CAN TAKE NOW
FROM THE RMA CREDIT RISK COUNCIL’S
2016 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.”
1 31 2 3
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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