Lender Solutions White Paper: Not All Vehicles Depreciate Alike

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1 Lender Solutions White Paper: Not All Vehicles Depreciate Alike

2 The current automotive landscape has proven to be very interesting for lenders as continued pent-up demand is driving expanded growth for vehicle sales SAAR has the industry on pace for somewhere between 15.5 and 15.7 million new vehicle sales according to Autoweek 1, a 10.3% increase from the 14.5 million units sold in Used vehicle sales are expected to crest above 40 million units, inching back toward their all-time high of 44 million during On the surface this may paint a rosy picture for auto lenders. However, an extremely competitive market that is forcing downward pressure on profit margins is challenging the opportunity for growth. One element driving this increased competition is lenders are becoming more aggressive in their lending practices, eroding profits further. In order to be successful, auto lenders are extending credit to lower credit-tier customers, loaning higher LTVs, and financing longer terms compared to their traditional customer profile. Opportunities still abound for auto lenders, though. Rather than cast a wide net and focus on sub-prime-targeted growth, auto lenders should identify specific vehicles that allow them to be highly competitive while mitigating added risk to their portfolio. In order to accomplish this, auto lenders need to understand collateral data that provide them with insight into historical and current depreciation patterns that can help forecast future growth. This is a key part of the process that helps auto lenders spot the differences in depreciation from one vehicle to the next, even within similar segments. What s more, vehicles depreciate at different rates throughout their lifecycle. This combination makes collateral data and a thorough understanding of depreciation trends even more important as auto lenders look to make the right decisions for their portfolio. Effects Of Customer Expansion It is easy to see why so many auto lenders have been focused on sub-prime. According to Experian data published in the International Business Times, auto lenders are re-focused on car shoppers with less-than-ideal credit scores. In fact, the rate of lending to these customers today has returned to near pre-recession levels and represents 45.2% of all car loans. This compares to 46.2% of car loans in 2008 at the height of industry activity just before the economic collapse 2. The reason behind this renewed focus is simple: Many of these consumers are in need of replacing their aging vehicles, and an economy that wants to improve has given them enough financial credentials to qualify for a loan. 2 Black Book Lender Solutions

3 The sub-prime focus comes with its own challenges for lenders. A report in The Wall Street Journal indicated that performance of loans to sub-prime borrowers is weakening, forcing bond issuers and investors to take on more risk. The twelve-month delinquency rate on sub-prime originations was 8% during the first quarter of 2012, up from 7% during the same period in 2011, according to the report 3. As such, collateral data has become even more important to help auto lenders recognize growth opportunities. Looking In The Rear View Mirror A critical element of collateral data revolves around historical vehicle values and patterns. This data must be regularly monitored and analyzed as the market shifts so auto lenders can learn from previous reactions. By constantly monitoring a portfolio and understanding typical depreciation of every vehicle, auto lenders can set a target amount for their loan-to-values (LTVs), terms and rates to determine how to adjust their portfolio and achieve lending objectives. This regular monitoring helps a lender avoid looking at the LTV twelve or eighteen months into a particular loan and realize they are not in the right position for a specific customer. Instead, they can be more proactive analyzing historical data trends. Having access to the right data with pinpoint accuracy is key to the entire process, ultimately enabling auto lenders to make profitable decisions based on trusted values. As an example, if a lender looks at LTVs on trucks after twenty-four months and most are under the targeted LTV range, they might consider extending the terms on trucks another twelve months and still mitigate their risk. This insight can be extremely useful especially as car shoppers are carrying more negative equity into the showroom. According to a report in Automotive News, 25.9% of new-vehicle car shoppers during the first quarter of 2012 had a trade-in with negative equity, up from 23.6% of customers during the same time previous year 4. These collateral positions can help make the right decisions on new vehicles added to a portfolio, but they can also help lenders with used vehicles and refinancing. Auto loan refinancing could top 14.1% of existing contracts by 2014, a 12% increase over 2012 levels according to Dealer Communications 5. The report says drivers are looking to refinance deals that were made during the more economically challenging years of Understanding vehicle value retention rates will help auto lenders determine the best portfolio balance. 3 Black Book Lender Solutions

4 How Can Data Make An Impact? Regularly monitoring portfolio inventory and collateral values allows auto lenders to realize the right level of aggressiveness for additional originations and refinancing. It can also help determine when to limit or adjust the balance of a certain vehicle in the portfolio, all based on the historical trends and projected future performance of the vehicle values. As an example, using the right vehicle value data can tell the recent three-year history, how it is currently performing, and how it will perform over the next three years. This can determine resale values and set the level of aggressiveness at auction. More importantly, data can shed light on how individual vehicles are performing historically and currently, which can lead to stronger and more accurate forecasting. Auto Remarketing recently published data from Black Book showing varying levels of retention rates on two-year-old vehicles. The information showed where one particular vehicle held 88.4% of its original value while another held 72.6% of its original value after two years 6. Tracking this data helps auto lenders determine how specific vehicles will perform based on historical patterns, and can guide more profitable portfolio decisions in the future. This is also a key element in the orientation process, particularly since lenders once again have an appetite for longer loan terms. By monitoring collateral trends on specific vehicles, lenders can look all the way out to full term and see what their equity position will be at different points in the loan. By regularly monitoring collateral trends, lenders can use this information as a tool to measure their risk and identify which specific vehicles represent opportunities to be more aggressive with lending policies and which represent areas to be more conservative. Lastly, a regular flow of data can help dictate how aggressive a lender wants to pursue collections based on where the collateral is positioned, and understanding the equity position can help identify when to begin the remarketing process. Overall, this collateral data can make an impact into setting the right game plan for every vehicle in an auto lender s portfolio by aligning strategies and validating models, especially since not every vehicle depreciates alike. 4 Black Book Lender Solutions

5 Figure 1 Sometimes there are similar depreciation patterns There are times when certain vehicles within a segment will depreciate at rates similar to one another. Figure 1 offers an example of two vehicles from the full-size car segment. Vehicle A has a 59% retention rate after the first year while vehicle B has a 50% retention rate after year one. Both vehicles follow similar depreciation patterns over the following years, and in year five they are still closely together as vehicle A has 39% retention and vehicle B has 29% retention. While there is slight shifting along the way there is a 9-point spread throughout until their retention rates align even more closely in year six. 5 Black Book Lender Solutions

6 Figure 2 In many cases, there are different depreciation patterns On the other hand, not all vehicles depreciate alike. Here are two vehicles shown in Figure 2 in the upper midsize car segment. Vehicle A retains its value at 62% after year one, while vehicle B retains 42%. Even more to the point, vehicle A shows an increase in retention in year three while vehicle B continues to lose value during the same time period, ultimately showing a 25-point spread. A lender would want to have access to this data in order to determine the right pricing on a one-year-old vehicle versus a twoor three-year-old vehicle. Lenders cannot assume that all vehicles within a segment will depreciate at the same rate, and it is important to rely on accurate and timely data to see the varying degrees of depreciation. 6 Black Book Lender Solutions

7 Figure 3 Vehicles can have a large spread early on There are times when the varying spread can happen at different points of a vehicle s lifecycle. Figure 3 shows two vehicles from the full-size pickup truck segment. After year one, vehicle A retains 68% but vehicle B retains just 39%, resulting in a 29-point spread. But in year four vehicle A has a 47% retention rate and vehicle B a 40% retention rate. Lenders would see that an older model for vehicle B is better for their portfolio than an older model for vehicle A, even though the reverse would be true if they were lending the same vehicles at new retail. 7 Black Book Lender Solutions

8 Figure 4 Sometimes two vehicles can start out similar and end up far apart As an opposite to the previous example, Figure 4 shows how two vehicles in the compact pickup truck segment start out close but then end up farther apart. After year one the two vehicles have just a 7-point spread, but immediately thereafter separate. After year four they have as much as a 31-point spread before settling more closely at a 15-point spread after year six. Again, regularly monitoring collateral values within a portfolio will show where opportunities to take on more risk reside at certain lifecycles of a vehicle. 8 Black Book Lender Solutions

9 Figure 5 When is the right time for portfolio addition during a vehicle s lifecycle? When comparing two different vehicles within the same segment, there can be drastic differences for retention rate depending on the lifecycle of a certain vehicle. Figure 5 takes a deeper dive comparing two vehicles and their retention rates after years one and four. This data is important to auto lenders considering the timing of allowing a certain vehicle into a portfolio and understanding how the data can show how the lifecycle can make an impact. Understanding historical depreciation curves in every vehicle, lenders would see that there are differences in when a vehicle s depreciation experiences a bigger decline depending on where it is in its lifecycle. Vehicle B s retention rate is more severe after year one compared with Vehicle A. However the reverse is shown between the same two vehicles after year four. 9 Black Book Lender Solutions

10 How Can Current Trends Impact Forecasting? Regular monitoring of portfolios and access to accurate historical and current data can often lead to the right forecasting of future retention rates. By understanding the historical depreciation of specific vehicles, lenders can use this data in combination with current conditions to see where a particular vehicle is trending. In Figure 6, steeper declines in retention early on in a vehicle s lifecycle may lead to stronger retention in the future. In Figure 7, the opposite pattern takes place where stronger-than-normal retention early on may lead to steeper declines later on in a vehicle s lifecycle. Figure 8 represents a more even depreciation curve where it has normal retention throughout. Lenders need to know at what point of the vehicle lifecycle they are creating terms for, and they also need to know what is taking place with current-day valuations so they can understand how those trends will affect the future based on its historical deprecation. Regular monitoring is important here to understand the current position as well as historical rates, which can help predict the future position of a vehicle. 10 Black Book Lender Solutions

11 Figure 6 Steeper declines in retention early on in a vehicle s lifecycle may lead to stronger retention in the future. Figure 7 Stronger-than-normal retention early on may lead to steeper declines later. 11 Black Book Lender Solutions

12 Figure 8 Vehicle lifecycle with normal retention over a six year period. 12 Black Book Lender Solutions

13 Summary The automotive industry is expected to grow steadily over the next several years. As pent-up demand continues to drive more need to replace aging vehicles, lenders will continue to compete heavily for business. This heavy competition will make it more difficult for lenders to elevate profit margins; therefore, finding additional pockets of growth through opportunistic lending on the right vehicles will be an attractive option. This strategy can prove costly, especially if lenders aren t regularly monitoring their portfolio. The identification of historic collateral values, current trends and projected performance is available through access to data that is timely, independent and accurate. Black Book s suite of values includes wholesale, trade-in and retail values that are updated on a daily basis giving lenders the ability to perform regular monitoring of their portfolios. Black Book also offers several tools to help with loss forecasting, which include historical trending, depreciation curves and Black Book Collateral Risk Score to help measure the impending risk of downward or upward movement in specific vehicles and vehicle segments. These tools are all offered with detailed analytics provided in a variety of file, portal, web or mobile platforms. For more information, please visit or call Black Book Lender Solutions

14 Appendix 1. Honda, Toyata, GM Set Pace As Sales Climb 14% ; Autoweek; August 2, Sub-Prime Auto Loans, Repos And Defaults Are Up, But Analysts Shrug Off Notion Of An Auto Lending Bubble ; International Business Times; June 7, Subprime Auto Loans Run Risk of Rapid Erosion, Moody s Says ; The Wall Street Journal; June 18, More car buyers are upside down, but that s OK, J.D. Power says ; Automotive News; June 5, Top Ten Most Refinanced Vehicles List Reveals Practical Ownership Choices by Below Prime Consumers ; Dealer Communications; June 14, Vehicles with Best Retention Values After 2 Years ; Auto Remarketing; May 7, Black Book Lender Solutions

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