BLACK BOOK WHITE PAPERF E B R U A RY 2 0 1 8

SUBPR IME & DEEP SUBPR IME :H O W T O R E M A I N C O M P E T I T I V E &

P R O F I TA B L E D E S P I T E G R O W I N G R I S K

According to the New York Federal Reserve’s report on household debt and credit1, auto loans that were 90 days or more delinquent represented 4.1% of the total amount outstanding during the fourth quarter of 2017, up from 3.8% in the same time from the previous year.

Lenders pay close attention to this trend, especially since these loans are represented with higher volumes to subprime candidates, as there is an increased likelihood that they will be written off.

Historically speaking, delinquencies fell to near-record lows following the Great Recession in 2009-2010, as auto lenders tightened lending standards significantly. As the automotive industry led the American economy out of the recession in the ensuing years, these lending standardswere loosened, helping to pave the way for several years of record-high auto sales of 17 million-plus annually helped along the way by a rise in lending to subprime and deep subprime customers.

The New York Fed also said during the second quarter that total outstanding auto debt, for both auto loans and leases, crested above the $1 trillion mark for the past eleven quarters straight.

Longer Loan Terms

It ’s not just the type of credit profile that can impact a portfolio and risks associated with loss frequency and severity. Length of loan term may have an impact, as well. Even with reports of subprime loan activity actually dipping a little, the length of loans continues to rise. According to Experian2, the average term for a new vehicle auto loan reached an all-time high of 69 months at the end of the third quarter.

Introduction

Following the recession, and as the economy has improved, an increasing number of lenders began to offer subprime and deep subprime loans and more independent financial institutions saw their way into the market, as well. At the same time, larger banks became full spectrum lenders that opened up space for subprime loan opportunities.

As this volume increased, these financial institutions began relaxing their lending criteria for credit and collateral to remain highly competitive for subprime and deep subprime. This meant higher loan-to-value ratios (LTV) using inflated values up front, placing even more importance on building the loan off the most accurate collateral value possible. As these LTVs rose, banks took on more risk, exposing themselves to more negative equity in their portfolio combined with longer loan terms, as well. Further, there is a correlation between how much equity a person has versus the propensity of default on a loan; as values decline, there is usually a rise in defaults.

Each of these factors has placed lenders of all size in a unique position – how to remain competitive even while risk increases. This white paper report will discuss the current landscape of subprimeand deep subprime loans, address the factors playing into the growth of risk associated with subprime and deep subprime, and explain how data is currently being used to help lendersremain competitive and profitable, despite these increased risks.

Delinquencies Continue to Rise

The subprime loan environment has become more competitive and it is expected to remain more competitive, even as delinquencies rise further.

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SUBPR IME & DEEP SUBPR IME :H O W T O R E M A I N C O M P E T I T I V E &

P R O F I TA B L E D E S P I T E G R O W I N G R I S K

Example A: High Term Scenario

Even in situations where customers have sound credit, risk can be amplified. In Example A, a higher term increases the risk on a customer; adding a layer of risk, the loan begins to feel more of a subprime environment, even if the credit score is high. A higher loan term adds to the severity of risk, increasing the potential for loss. Collateral data can help lenders determine which vehicles and segments have varying intervals of depreciation, which can help determine risk levels.

Where (and How) to Find Profit in Subprime

When a lender is looking to evaluate the amount of risk tolerance in a long-term loan, there are four things to consider: How much initial loan-to-value they want to establish; the rate of annual depreciation of the collateral; credit profile of customer, whether subprime or prime; and determine if the Risk-Adjusted Return on Capital is sufficient.

Collateral data can help bring the rightdecision into focus. Data can help determine the loan-to-value ratio during origination, historical depreciation patterns, and the projected residual forecast based on the desired time frame for the loan term.

Profitability on loans underwritten to traditional standard terms lack the desired loan margin at current low rates. Increasing risk is the common method to profitable growth in a market exploding with competitors. Many lenders seek the opportunity to enhance their portfolio margins through the portfolio management via increasing loan terms vs. relaxing credit criteria.

Collateral Data, Residuals & Analytics to Determine Risk Growth

Following are a few examples of how collateral data and residuals, combined with advanced analytics, can help lenders determine where, when, and how to take on more subprime and deep subprime risk in their portfolio to remain competitive and maximize profit potential.

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Example B: Higher LTV Scenario

In Example B, this particular vehicle is experiencing a higher LTV, which means it won’t reach a point of equity until month 30. The LTV is set at 130, and the loan term is 60 months. A higher amount borrowed against the vehicle value makes it higher risk, taking longer for this loan to reach equity position. Having this level of collateral insight on the LTV helps lenders determine their appetite for risk in their portfolio on this vehicle.

Example C: Higher LTV, Higher Term, Higher APR, Higher Depreciation

Similar to Examples A and B, the number of risk layers can add a significant amount of pressure on a lender ’s portfolio. Here in Example C, there is a vehicle that shows a higher-than-average LTV, term, APR, and depreciation rate. Each of these layers adds risk to the portfolio. Having access to data and analytics in each of the varying risk layers can help lenders determine their appetite for risk.

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How Will Lenders Use Advanced Valuation Data for Subprime Loans

Increased pressure to keep pace with the high annual sales rates of just a few years ago means the automotive industry will remain highly competitive in the coming years. One area that will continue to see increased competition will be for subprime loans to individuals with less-than-stellar credit. With the right collateral insight based on advanced depreciation data and analytics, auto lenders focused on the subprime market can better determine their risk levels to remain competitive and focus on profit potential while keeping risk levels at bay. What’s more, these data and analytics can now be offered to help provide better visibility into custom-build portfolio scenarios with a focus on each vehicle’s specific VIN and individual history report. No two vehicles depreciate alike, and collateral data can now assign a specific value to each vehicle, even of the same year, make, and trim level.

About Black Book

Black Book® is best known in the automotive industry for providing timely, independent, and accurate vehicle pricing information, and it is available to industry-qualified users through online subscription products, mobile applications, and licensing agreements. A leading provider since 1955, Black Book has continuously evolved to ensure that it achieves its goal of delivering mission-critical information to its customers, along with the insight necessary to successfully buy, sell, and lend. Black Book data is published daily by National Auto Research, a division of Hearst Business media, and the company maintains offices in Georgia, Florida, and Maryland as well as Canadian Black Book in Toronto.

Lenders use Black Book data to identify risk within their existing portfolios and act on opportunity. Industry insiders andthird-party vendors license our data toevaluate trends. Original equipment manufacturers (OEMs) rely on data and insight to fully engage more customers.

Their dealerships subscribe to our data services to evaluate pricing and book vehicles. And retail locations leverage Black Book’s technology solutions to turn their websites, mobile sites, and Facebook pages into the industry’s best lead-generating solution.

Black Book continues to evolve with meaningful innovation. Our custom and cutting-edge mobile applications provide insight that saves time, builds portfolios, and facilitates sales.

For more information, please visit BlackBook.com or call (800) 554-1026.

Appendix

1: “Quarterly Report on Household Debt and Credit”; Federal Reserve Bank of New York; February, 2018

2: “Subprime loans for autos show a big decline as term length hits a record high”; Phil LeBeau, CNBC; December 7, 2017

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