HOW TO RESPOND TO CAR LOAN DELINQUENCY RATES IN GOOD TIMES AND BAD

The Kansas City Federal Reserve’s MAIN STREET VIEWS Policy Insight Auto Loan Delinquency Rates Are Rising, but Mostly among Subprime Borrowers focuses on auto finance trends of the last 7 years. It’s well worth a read, especially for the data about newly-issued auto lending industry debt. Among its findings on car loan delinquency rates are:

• There has been a steady increase in U.S. auto debt over the past seven years;
• The increase in auto debt is mainly from prime borrowers (credit scores > 620);
• Overall auto delinquency rates began to rise in 2015;
• The increase in auto delinquency rates appears to be attributable to subprime borrowers (credit scores < 620);
• The delinquency rates among subprime borrowers grew from 12.4 percent in 2015 to 16.3 percent by 2Q 2018; and
• The average delinquency rates of prime borrowers, who hold the majority of outstanding auto debt, are essentially unchanged.

The following charts from MAIN STREET VIEWS | Policy insights from the Kansas City Fed provide a clear picture of the trends and underlying factors.

Real Auto Debt Outstanding

Car Loan Delinquency Rates (90+ Days Delinquent)

Share of Newly Issued Auto Debt by Loan Industry

These data, distilled to their essence, indicate that while prime borrowers account for the increase in auto debt, subprime borrowers account for the increase in delinquencies since 2015. They also show that auto financing companies appear to more willing to assume subprime borrowers compared with other types of lenders.

Auto financing companies issued 44 percent of prime debt and approximately 66 percent of subprime debt in Q4 2017. Even though subprime borrowers account for a low percentage of outstanding debt, the auto financing sector exposed to subprime risk needs to act cautiously.  

Good Times for Prime, Bad Times for Subprime

Despite the economic upturn of recent years, not all boats are rising. Borrowers in all lending segments have taken on additional debt, but subprime borrowers are bailing. Some reasons for subprimes’ debt struggles include:

• Longer loan terms of 72 to 84 months that offer lower monthly payments but are statistically associated with higher car loan delinquency rates.
• Double-digit subprime interest rates that increase total loan cost.
• Consumer preference for higher-ticket vehicles (primarily light trucks and SUVs).

While subprime borrowers are not a concern for most banks or credit unions who historically maintain conservative lending policies, the auto finance companies can reduce the risk of delinquency in two ways: data-driven applicant qualifications and analysis of car loan delinquency and default rates in their portfolios.

Data-Driven Applicant Qualification

Lenders can reduce car loan delinquency rates by taking advantage of fintech innovations to identify high-risk applicants as well as enable data-driven applicant qualifications. Fraud analysis and alternative credit data make this possible.

Identify Fraudulent Car Loan Applications

Fraud has become the main way to steal cars.  Whether you focus on prime, subprime or both, identification of fraudulent applications is the most direct means of reducing car loan delinquency rates. Through extensive analysis of millions of car loan applications, machine learning can identify overt and subtle indicators of fraud. These include misrepresentation of employment and income, “straw borrower” that hides the real identity of the applicant and synthetic identity that is a blend of false data.

Loan applications are analyzed in real-time and assigned a risk score (1-to-999, low-to-high) and a reason code that lenders can use as a factor to approve, review, or decline applications. With the increase of loan application fraud and resulting delinquencies and defaults all lenders should include fraud analysis in their loan origination process.

Make Data-Driven Credit Decisions

Today lenders have far more consumer data available to determine applicant creditworthiness. In addition to the traditional credit bureau data, alternative credit data now gives lenders a more detailed assessment of applicant creditworthiness.

Alternative credit data is sourced from a wide range of transactional data generated courtesy of an ever-growing digital economy. That data can include employment history, income statements, banking accounts, real estate records, rental payment history, and payment records for electricity, gas, water, cable, and cell phone.

When alternative credit data is combined with traditional bureau data, the result is a more detailed picture of application creditworthiness. This gives lenders greater confidence in lending decisions, whether the data is used for auto-approvals, auto-declines, or further review and decisioning by experienced underwriters.

Lenders recognize the value of alternative credit data and Experian’s 2018 The State of Alternative Credit Data report confirms this. Approximately 80 percent of lenders surveyed reported using FICO scores and at least one alternative credit data source. Sixteen percent used or planned to use utility or rental payment records. Overall, lenders believe alternative credit data gives greater confidence in determining a borrower’s ability to pay, leading to better quality lending decisions—and lower car loan delinquency rates.

Good Times or Bad

Concern with delinquencies varies by lender; lenders who assume risk in subprime markets tend to be especially concerned. However, delinquencies are not exclusive to subprime market segments; all lenders—banks, credit unions, and finance companies—can benefit from fintech advancements that help reduce auto loan delinquency rates. In good times and bad, reducing delinquency rates is always a best practice.