Engine of growth

Despite a dip in new-car sales, auto lending can be a fertile area for many community banks.

By Ed Avis

Two years ago, the leaders of Farmers State Bank in Waterloo, Iowa, decided that auto lending should become a larger part of the bank’s portfolio. Their timing was good: Because of the strengthening economy, demographic changes and other factors, car sales jumped 4.8 percent in 2016 to a record 88 million vehicles worldwide. And when more cars are sold, more cars are financed.

“We made a conscious effort to increase that part of our bank’s lending, and all the stars lined up,” says Todd Rohlfsen, president of the $850 million-asset community bank, which has 10 branches in northeast Iowa. Farmers State Bank carried about $34 million in auto loans in 2016, up from about $20 million in 2015. “We’ve been very happy,” Rohlfsen says.

Farmers State Bank is not alone among community banks. According to data from Sageworks, banks with less than $1 billion in assets carried $13 billion in auto loans in 2016, up .07 percent from 2015. That doesn’t mean there aren’t some challenges, but overall, auto lending is a bright spot for many community banks.

“There is a lot of consumer confidence right now, and people are looking to make larger purchases, such as cars,” says Rob Ashbaugh, senior risk management consultant at Sageworks. “There are a lot of banks that have had significant growth in that sector.”

Naturally, the economy is a key driver of auto lending, and the economic recovery over the past five years—albeit slow—has moved a steadily increasing number of cars off the lot.

Used-car strongholds

New cars, because of their high price points, generate a lot of financing need. But that’s also where the automakers’ own finance arms are strongest. Financing used cars, on the other hand, is something community banks dominate in
many markets.

“I like the used-car market,” says John Buhrmaster, president of 1st National Bank of Scotia in New York and a past chairman of ICBA. “Families need second cars, and some are buying a third car for their young-adult children. That’s become an excellent market for us. If you’re buying a car for your kid, you’re looking for a small amount, which big banks don’t like. But you have a good payment record, and you want to put the kid on the loan so he can establish credit. That’s a community bank loan all the way.”

Buhrmaster says auto loans make up about 35 percent of his bank’s portfolio, and that’s split about 50/50 between new and used cars.

Like the new-car market, used-car sales have been strong in this economy. According to Mannheim’s Used Car Market Report, 2017 was the seventh consecutive year that used-car sales increased in the United States.

“I like the used car market. Families need second cars, and some are buying a third car for their young-adult children. That’s become an excellent market for us.”
—John Buhrmaster,
1st National Bank of Scotia

The strong economy has also had an effect on buyers’ qualifications. According to the 2016 International Automotive Lending & Leasing Survey, 73 percent of auto lenders do not expect to make any changes to their underwriting and credit quality standards this year, and 9 percent plan to tighten standards. Those data imply that the majority of lenders feel consumer creditworthiness is strong enough that they don’t need to loosen standards to stimulate lending.

A strong economy makes for a fertile financing environment, but banks need an important partner to succeed in auto financing: car dealerships.

Auto buyers have several choices when they seek financing. They can use the automaker’s “captive” financing, such as American Honda Finance Corporation; they can seek financing from some other source, such as AAA or an online-only lender; or they can seek a loan from a community bank. Sometimes getting a loan from a community bank involves getting preapproved by the bank before the car is purchased, but most commonly the transaction is initiated at the dealership itself.


Increase in auto loans between 2015 and 2016 at banks with less than $1 billion in assets

“Our indirect business [loans through dealerships] is a steady business, and that’s because of the relationships we have with the finance managers at the dealerships,” Buhrmaster says. “The finance manager knows nothing will get screwed up if he works with us. The worst thing that can happen is to pass a loan to a customer and have it go wrong, because then that customer will go to someone else next time.”

Making connections

1st National, which has about $450 million in assets, has relationships with 90 auto dealerships, Buhrmaster says. That’s a lot of relationships to maintain, and one way the bank does that is by dedicating an employee to that market.
“We have a retired auto dealer on the road every day visiting the dealerships, just stopping in, seeing if they need help with anything, bringing them supplies, taking them to lunch once in a while,” Buhrmaster says. “And he speaks their language.”

Good relations with dealerships is one reason Farmers State Bank saw good growth in 2016. Rohlfsen says the bank established several new dealer relationships in nearby Waverly, a community in which his bank previously did not have much auto-lending presence. Also, the community bank changed how it compensates dealers to a flat $45 fee instead of basing compensation on the interest rate. “When we went away from basing how we buy the contract from the interest rate to the flat fee, that helped,” Rohlfsen says. “It makes it easier for the dealerships.”

He says his bank also lowered its interest rates on used-auto loans, which naturally made its offer more attractive to buyers. But lowering rates is not always required for growth: Buhrmaster says 1st National has seen auto-loan growth this year even while raising rates.

In the end, success in auto lending may come down to the one advantage community banks always seem to have over the competition: hands-on attention to customers.

“It comes down to service, to taking the application and turning it around quickly,” Ashbaugh says. “Rate obviously helps, but that being said there are a lot of great rates out there now, so it does come down to service.”

Ed Avis is a writer in Illinois.

Challenges ahead

Auto lending among community banks is not without challenges. For example, the positive trends in both new and used cars may be changing. Automakers have reported slower new-car sales in 2017 than expected. Ford, for example, reported that sales of light vehicles dropped 7.2 percent in March compared to the year before.

On the used-car side, J.D. Power Valuation Services reported that used-car prices dropped about 4 percent in 2016, the first slide since 2008. Lower car sales, and lower used-car sale prices, naturally affect the profitability of banks that offer auto lending.

Another challenge is the potential for more government interference in the market. The 2016 International Automotive Lending & Leasing Survey found that 21 percent of US banks feel compliance is a challenge to growth and profitability, which follows only technology concerns on the list of challenges.

“Government interference is one thing that can hurt the business,” says John Buhrmaster of 1st National Bank of Scotia. “If the CFPB [Consumer Financial Protection Bureau] gets involved, that will kill the business for community banks. But the trend is that the CFPB is not going to interfere.”

Buhrmaster says another government concern is federal investigations of discrimination claims against auto lenders. “The Justice Department has been coming after auto lenders for what I consider fake discrimination claims,” he says. “That doesn’t seem to be the case with [the current presidential administration], but it does seem to have been with previous administrations. That’s a threat to the industry.”

Regardless of those challenges, auto lending stands to play an important role for community banks for a long time.

“It’s a fun business. It’s a thrill ride,” Buhrmaster says. “You have to have the stomach for it, because you take some losses. But as you learn the business, it can be a huge success.”