Hot Wheels

“We fear this could be a bubble.” —Troy Peters, Jonestown Bank & Trust Co.
“We fear this could be a bubble.” —Troy Peters, Jonestown Bank & Trust Co.

Competition and regulatory risk in car lending race off

By Howard Schneider

Vehicle loan originations reached almost $120 billion during the second quarter of 2015, states the New York Fed’s Household Debt and Credit Report. It was the highest three-month total for car loans recorded over the last decade.

A Bubble to Burst?

Credit union pricing competition turns irrational

Indirect auto lending has played a major role for Security Federal Savings Bank in Jasper, Ala. Half a dozen years ago, the community bank held $13 million in auto loans. Today Security Federal Savings’ vehicle-lending portfolio has been reduced to $3 million. Currently the bank has a little less than $40 million in assets, according to President and CEO C. Todd Thompson.

Tax-exempt credit union competition is the main culprit for the bank’s decline in auto lending, Thompson says. “They’re extraordinarily aggressive [in loan pricing],” he says, “and we’re not trying to compete.”

Current lending practices can’t produce profitable car loans, Thompson adds. Credit unions are pricing their used-car loans at a fixed rate of 3 percent for 72 months, he says. Borrower credit scores are as low as 580 in these deals, he adds, and their loan-to-value ratios can reach 110 percent.

Security Federal anticipates that write-offs on such loans will be equivalent to the borrowing rate. “It doesn’t leave much margin,” Thompson observes.

Thompson is allowing Security Federal Savings’ auto-lending portfolio to “shrink dramatically” rather than trying to compete irrationally. “We’ll wait until sanity returns” to get back into auto loans, he says.

—Howard Schneider

ICBA Member Poll

What types of auto loans does your community bank offer?

Direct loans to consumers for used autos

Direct loans to consumers for new autos

Direct loans to consumers to refinance existing auto loans

Indirect auto loans

Dealer and lease financing

The Consumer Financial Protection Bureau has pursued higher requirements of banks to oversee end-user costs and fees for their indirect auto-lending relationships. How has your bank changed the way it offers indirect auto loans due to CFPB guidance?

No changes

Changed dealer compensation

Considering exiting auto lending

More selective about dealer relationships

Considering changing dealer compensation

Stopped making new auto loans

Sold auto-loan portfolio

Despite the recent uptick in activity, auto lending has been a healthy business line for years at Jonestown Bank & Trust Co. in Jonestown, Pa. “We did extremely well during the financial crisis,” offers Troy Peters, the community bank’s CEO.

Many other lenders stopped providing car loans at that time, Peters recalls. But competition in Jonestown Bank’s marketplace has picked up further in recent years. He says loan-to-value ratios can reach 130 percent now, as consumers who haven’t finished paying off their current vehicle loan roll their existing loan balances into new car loans. However, Jonestown Bank, a $450 million-asset community bank, isn’t willing to compromise its underwriting standards, and its portfolio is declining as a result.

In August, a three-person team at Jonestown Bank approved 156 car loans totaling $2.3 million. However, that volume wasn’t enough to cover a runoff of balances in the bank’s $65 million car-loan portfolio overall, which reflects intensified competition for auto loans in the bank’s marketplace, Peters says.

As a result, some community banks experienced in auto lending like Jonestown Bank, have learned to be cautious about over-concentrating in the sector as of late. “We fear this could be a bubble,” Peters says.

A running start

MainStreet Bank in Fairfax, Va., entered vehicle lending by purchasing an $80 million car-loan portfolio and also picking up a six-person auto- lending division, which handles every aspect from origination to collections. The community bank is trying to build that portfolio to $100 million to $125 million, says Jeff Dick, the bank’s chairman, CEO and president.

MainStreet Bank has close to $500 million in overall assets. Senior Vice President and Chief Consumer Lending Officer Richard Johnson heads its auto-lending efforts. Using technology allows the bank to compete against larger lenders, and using technology and personal service to build relationships with both dealers and borrowers is key to the success of the bank’s auto-loan program, he says.

MainStreet Bank targets established, locally owned dealers. Its other bank products are cross-marketed to borrowers once they receive their auto loans.

Traditionally bank auto lenders have quoted a car dealership a rate that the dealer could raise to increase its profit. But that practice is drawing fair-lending scrutiny from regulators and, as a result, is being replaced by flat-rate compensation to dealerships on a per-loan basis. For community banks, the yield on an indirect consumer loan portfolio is attractive, because it performs similar to short-term bonds. The average duration for MainStreet Bank’s indirect consumer loan portfolio runs 28 to 32 months.

It’s “a diversification play for the bank’s loan portfolio,” Dick explains. “And in the current rate environment, it is good for interest rate risk management.”

More revenue

Yet community banks that stay with prudent auto-loan underwriting—conservative principles that community banks commonly follow for any lending—are finding opportunity now. Indirect auto lending became profitable for First Reliance Bank in Florence, S.C., within 12 months of the program’s kickoff last year.

“The bank wanted another revenue stream,” explains David Hall, the $400 million-asset community bank’s senior vice president of dealer services. Hall is a 25-year auto-finance veteran who came to First Reliance with established relationships with dealers.

Auto lending “can be a long-term, profitable business line,” he says. But “it’s not to be taken lightly,” because indirect lending can carry more regulatory risk than traditional consumer lending. Bankers never meet the borrowers and must rely on auto dealers to provide accurate information about their customers.

Hall urges community banks to be certain they have thorough controls in place for everything from dealer selection to loan servicing. Additionally, banks must monitor dealers to ensure they are complying with fair lending laws as they extend credit to consumers.

Auto dealership service is integral to First Reliance’s approach, Hall says. The bank’s auto lenders work until 7 p.m. on weekdays and 6 p.m. on Saturdays. Software automation helps them reach their goal of making loan decisions within 20 minutes of receiving an electronic application.

Typically the auto-loan applications First Reliance receives are carefully reviewed, and if they meet the bank’s underwriting guidelines they are approved as submitted, or the underwriter may make a counteroffer to the dealer, Hall says. Review of a borrower’s ability to repay, credit history or the loan-to-value ratio of the originally submitted application may cause First Reliance to offer to lend less than the amount originally requested, for instance.

While community banks typically focus on prime loans, they also must be willing to approve some borrowers with low credit scores to gain loyalty from dealers, notes Jonestown Bank’s Peters. Placing “a small percentage” of subprime loans in a portfolio also helps reach the bank’s desired return level, Hall explains.

Hall points out that it’s difficult for small- to medium-volume auto lenders to make a profit on super-prime borrowers. Loan pricing margins are typically too thin for auto loans, he says, which requires a large volume of originated loans to achieve a reasonable profit level. Such high-volume auto lending also can cause loan concentration risk.

To be successful in auto lending today, Hall continues, a community bank needs to be prepared to book some mid-tier and subprime loans to achieve worthwhile yields. Other requirements for success, he says, include having a knowledgeable leader who understands the local car dealer marketplace and an experienced loan and collection staff to withstand keen regulatory scrutiny in this credit niche.

Howard Schneider is a freelance financial writer in California.