By Ray Birch
BIRMINGHAM, Ala.—Used car demand could go up and loan terms might go down—along with loan rates—asserts one automotive industry analyst, who believes the Financial Accounting Standards Board’s (FASB) current expected credit loss model (CECL) could have a significant impact on auto lending.
Lenders will also need to start considering another factor they typically haven’t, the same analyst suggests.
Anil Goyal, executive vice president of operations at Black Book, spoke with CUToday.info about the pending FASB accounting change that requires lenders to set aside reserves for future losses based on the life of the loan rather than the current standard requiring just one year out based on incurred losses.
Changes in Collections?
Goyal, too, believes CECL will lead to changes in collections and that risk managers will get involved in the pricing of car loans.
“Institutions that tend to price loans higher will really have to consider how that higher pricing impacts their loan-loss probability,” explained Goyal. “So, if you have a higher-priced segment of your portfolio, what impact does that have on your loan loss probability?”
Goyal contends closer examination of lenders’ higher-priced book of business could lead to lower rates for borrowers who fall into some of the riskier categories.
“Some consumers could get better rates,” asserted Goyal. “If you give a risky borrower with a very high rate, say 15%, that may increase the likelihood that the borrower eventually can’t handle the monthly payment and lead to default. So, now I have to reserve more for that expected loss. But give that same consumer a 12% rate, and their ability to repay is greater, the likelihood of default is less, and the lender has to reserve less for that loan, as well.”
Goyal said he expects risk managers to get closely involved in the pricing of loans when CECL is effective.
“Typically, rate is a marketing/pricing team decision,” noted Goyal. “CECL will just draw more risk managers into pricing decisions, as those decisions will impact loan losses.”
An Effect on Terms
As CUToday.info has extensively reported, loan terms have been steadily extending over the past few years to keep payments affordable as vehicle prices reach record levels. Goyal said CECL could slow that trend, primarily for riskier borrowers.
“CECL could have an impact on terms,” said Goyal. “You reserve for five years instead of seven and your reserve requirements are lower. Terms will remain higher for prime customers, where default levels are low. But I look for lenders to tighten terms for subprime borrowers.”
And as terms are reduced for certain borrower segments, that will influence the price of the vehicle these customers can afford, Goyal pointed out.
“This could have more of the subprime borrowers looking at used cars,” said Goyal. “Vehicles that have depreciated more in value will get more attention. Used vehicles are already more in demand; this will only increase that trend.”
New Factor to Consider
Lenders will also now have to pay closer attention to collateral value, and how well a vehicle brand or model will retain its value.
“A factor that lending institutions have not considered, really, is lifetime loss given default—what is my loss if a loan defaults six months or 48 months from now and that loss is impacted by the by what the collateral value will be for that car. This means really looking at residual values in your loss forecasting scenarios. Lenders need to make sure they are getting accurate data on collateral values.”
Residual values are becoming a bigger issue when a loan defaults, noted Goyal, as many more borrowers—in record numbers—are upside down on their loans.
“It is getting worse,” said Goyal about negative equity in financed vehicles. “The terms are getting longer and consumers may be buying more than they can afford. But it really depends on the economic cycle as well.”
Greater attention will need to be paid to collections, as well, noted Goyal.
“Lenders collect on all types of borrowers who default. But they may now have to prioritize attention more toward higher-risk borrowers,” he said.