Deflating a Vehicle Repo Bubble Before It Pops
Lurking in the background behind the spotlight of record auto lending activity are the financial losses that occur when loans go bad.
In 2013, there were approximately 1.4 million vehicle repossessions in the United States, according to Auto Financial Group, a Houston firm that provides residual-based finance products for credit unions. The average charge-off per vehicle for credit unions was approximately $7,317 per unit and for banks, $7,618. Taking the average loss between banks and credit unions, which is estimated at $7,400, it would come to approximately $10.3 billion in losses, AFG found.
“It really is not too hard to predict whether repossessions will increase,” said Dave Langley, vice president of operations at AFG. “New and used vehicle sales are on the rise. As a result, all financial institutions are booking more loans and leases. As the competition for buying paper increases, institutions are relaxing their credit requirements.”
Over the past 10 years, credit unions have become far more aggressive in buying vehicle loans, Langley said. With that portfolio growth comes the assumption of added risk and the potential for losses from defaults, he added.
Given all these variables, are credit unions prepared for a bubble within the auto lending sector? When it comes to repossessions, some of them do whatever requires the least amount of effort and resources, according to AFG.
To illustrate, 20 repos per month at an average loss per unit of $7,400 would come out to $1.7 million in losses for the year, the company noted. If a credit union could get an average of $300 more per vehicle during that same year, it would recover another $72,000.
Langley said because most credit unions are localized operations, they will sometimes simply put their repossessions on their parking lot and attempt to sell them to their members, or over the Internet. While it may seem like a simple process, this kind of a transaction is essentially a retail sale, he reminded.
Nearly all state statutes require some level of warranty protection for a buyer, Langley explained. Therefore, the credit union is legally bound by the specified state protections. This can prove to be problematic should a vehicle experience a major failure, he said, adding that it can take a considerable amount of time and tie up capital.
Other credit unions may use local dealers or auctions to liquidate their assets, which can be a quick and easy method but can fall through if there is no way to accurately assess the degree of financial success achieved with each liquidated asset.
Among the questions credit unions need to ask is do they know and track historically what they are getting for their repossessed vehicles on an ongoing basis, including average loss per unit broken down by type and year, which vehicles are getting better dollars at auctions and which ones will bring more outside of auctions. Ultimately, how much is it costing the credit union today, based on their current process, to assign, repossess, recondition and sell a repossessed vehicle with all the myriad of fees thrown in?
“A unique feature of credit unions is their commitment to members. Banks, captive finance (and) subprime lenders, tend to be quicker than credit unions in repossessing a vehicle when a loan is in default,” Langley said. “Credit unions take a more proactive position when trying to correct a default situation. While this is a laudable industry practice, when a decision finally is made to repossess a vehicle, the condition of the vehicle is typically very poor.”
How is collateral tracked at any point in time is another area that can't be overlooked, Langley said. For instance, if a member is looking at purchasing a used car and is interested in a credit union's repossessions, do they know how long it will take to get the unit back to the credit union?
“A factor that many financial institutions overlook when managing repossessions is the impact that industry volume has on the success of liquidating vehicles,” Langley said. “When retail new vehicle sales plummeted in the 2007 to 2010 time period, it followed that there was a shortage of available used vehicles in the 2010 to 2013 timeframe.”
This drove wholesale used vehicle prices to historic highs and severely decreased the volume of vehicles passing through the auto auction process, where most repossessions are liquidated, Langley pointed out. At one point, getting good values for used cars was not difficult but that environment has since changed as the industry is moving into a more normal used vehicle inventory level and auction volumes are back to pre-2010 levels, he said.
According to Experian Automotive, repossessions were up 42.8% in the fourth quarter of 2013, going from 0.46% in Q4 2012 to 0.65% in Q4 2013. However, the increase was driven entirely by finance companies that provided a significant majority of their loans to credit-challenged customers. That boost could also be attributed to a tightening of repo standards, said Melinda Zabritski, Experian Automotive's senior director of automotive finance.
Generally speaking, credit unions are doing a good job when it comes to handling their repossessions, said Trace Ledbetter, EVP of service at State National Companies, a Bedford, Texas-based insurance company that counts credit unions among its clients. However, as repossessions increase, they could look to maintain the efficiencies gained in their collections departments.
“Make sure they are handling vehicles as efficiently as possiblem especially as borrowers may have become more mobile during the downturn and may now reside outside the original geographic location of the credit union,” Ledbetter suggested.
Credit unions should also make sure they are getting the benefit of any losses on repossessions where insurance exists on the vehicles by filing claims with the insurance carriers in order to reduce the amount being charged off and minimize the amount charged against the borrower's credit, Ledbetter said.
State National Companies is generally seeing a slight increase in the frequency of repossessions, off of the lows that occurred around late 2011 and very early 2012, Ledbetter noticed. There has been a more significant increase in the loss severity, for instance, with higher balances being charged off. Other loss types related to credit quality are increasing as well, such as skips, which tend to have higher charge-off amounts associated with them, he noted.
As lenders continue to compete for loans, Ledbetter said he expects to see an increase in both repossession and skip- type losses.
Vehicle repossessions are remaining relatively flat for most lending institutions even though auto loan debt per borrower has increased, said John Hannegan, SVP and operations director for HUB Financial Services, which serves roughly 120 credit unions and is a division of HUB International Limited, a global insurance brokerage in Chicago.
“Financial institutions became much more conservative in their lending practices the years following the recession of 2007 and 2008 and their delinquencies and repossessions have been positively impacted,” Hannegan said. “Recently, there have been some increases in delinquencies in the subprime market but these are primarily due to loosening credit standards in that arena.”
Ledbetter emphasized that overall delinquencies and repos are still near all-time lows while Hannegan is seeing relatively flat activity even though auto loan debt per borrower has increased.
“We may be feeling the adjustment back to more historical norms, which increases the need for credit unions to proactively protect themselves from losses on loans collateralized by automobiles,” Ledbetter said.