Aug 11, 2022
The pandemic and its aftermath have continued to shape the world of auto lending. We are in unprecedented times in the auto-lending industry with the chip shortage, rising car costs, and market instability. Economic downturns always raise many questions for lenders, so we thought we would get ahead of answering some.
For starters, Open Lending is responding to current marketing conditions, including rising car prices for both new and used, loan payments and terms, and risk analytics. One of the things we did recently to address the rising car prices and payments is expand loan terms from 75 months to 84 months. The unaffordability of cars is at an all-time high, so adding an extra nine or 12 months allows the payment to get back to a level that’s more in line with people’s expectations before the pandemic and the resulting car pricing increases.
Open Lending also reconsidered our maximum loan amounts as they were no longer in line with the current market. As a result, we increased loan amounts to bring Open Lending more aligned with current market expectations. According to Cox Automotive, the average price of a new car has risen substantially to more than $43,000 in May, up $700 from April. The average used car is now $33,000, Autoweek reported. This has affected the amount car buyers need to finance at your bank or credit union. We want to help make car ownership as accessible as possible to those who want and need it.
We are looking into expanding to allow for older vehicles. The current average age of cars on the road is 12.2 years, which has increased over the last five years, according to Carscoops. Excluding light trucks, cars are even older than that. As car prices and inventory are now where the average age of vehicles being financed is going up, and cars are staying on the road a lot longer, we’re looking at broadening our model-year eligibility to account for a larger volume of older cars being financed.
Open Lending regularly communicates with our A-rated insurance company partners to ensure the soundness of our portfolio and coverage. Default frequencies have increased slightly, but they are still in line with market expectations and historical figures – even below pre-COVID numbers, according to the New York Fed.
We have built our system based on the 2003-2008 data, so taking into account the data from that recession, our portfolio would have to take on three times the defaults that occurred in 2008 before our insurers would reach a point that they would be unable to handle or pay claims. Even then, the severity of claims has gone down so much that it would likely have to worsen.
At Open Lending, we’re projecting auto manufacturing to continue to fall behind demand due to the chip shortage. As such, it’s unlikely to see a recovery on the supply side until 2023, perhaps even early 2024. Manufacturing remains behind 2019 levels.
Non-prime borrowers are not likely to be significantly affected by the rising interest rates caused by inflation. Even in a recession, we found that non-prime auto loans weather a downturn better than those with higher credit scores and incomes. Given the supply constraints, it will be tough to grow a lot in this market. Still, we believe we’ll continue to see car values stay at an elevated level for the foreseeable future until that supply side is corrected.
Read How Union Square Credit Union Increased its Auto Loan Portfolio 21%!
As the auto market begins to even out, it will not be a sudden correction but a slow and steady recovery. As a result, lenders likely will only need to make slight modifications or adjustments to account for risk in their underwriting. That could be pricing your loans a little bit higher to account for the increased severity that car loans could experience when car values come down.
So, what are the different factors for consideration in all of the above: for new versus used, direct versus indirect, and across different makes and models, regionally, etc.?
Used car values historically tended to be less risky because the minute a brand-new car is driven off the lot, it experiences some depreciation. However, it’s almost an inverse relationship today because new vehicle values have stayed consistent, and the manufacturers have an invoice price or MSRP that hasn’t changed through the pandemic. We’ve read reports of people paying more than MSRP for their vehicles! New cars are still being sold to dealers at a relatively consistent level, whereas the used car market has experienced a jump in value. That’s also something to keep in mind when prices begin normalizing.
For example, most credit unions are heavily invested in the used car market and have not been doing much in the new car market; that is something to consider as there are differences in value retention across makes and models. For example, Toyota models tend to hold their vehicle values much better than others. So if you’re making car loans today, then 15-18 months down the road, certain makes and models will tend to have a much higher severity of loss than their counterparts just because of the residual value and where they’re going to be at the time when you typically see a default.
The long and short of it is if you’re monitoring make and model depreciation in your portfolio and you have indirect relationships with a dealer that sells one of those makes or models that depreciates at a much faster rate, you want to consider making some pricing adjustments or switch to dealer-specific pricing to account for that higher severity of loss potential. Open Lending can help!
Open Lending offers Lenders Protection™, a risk management program featuring default insurance coverage for near- and non-prime auto loans. The Lenders Protection™ program is a unique auto lending enablement platform that allows financial institutions and other auto lenders to model their specific overhead and funding costs and set a target ROA for their insured portfolio.
The result is a profitable auto loan portfolio with carefully managed pricing and risk characteristics. Open Lending can allow you to provide more auto loans outside your standard prime lending guidelines and book more approved and conditioned loans. Open Lending is prepared to deal with the constant changes the lending landscape brings, and when you utilize our Lenders Protection™ program, you can be too.
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