Back

Apr 27 2018

What Do Auto Loan Delinquency and Charge Off Trends Mean for Credit Unions?

Article

Written by markadmin

4 min read

BY JEFF JOHNSON

I have read articles recently describing the potential rise in auto delinquencies and charge offs. I often wonder to myself as to how applicable these numbers are to credit unions or to a specific credit union. Historically credit unions have trends that differ, or that may not be as pronounced, as other lenders. Also, some trends may only be specific to certain regions. It is important to analyze these trends using credit union and regional data.

I made note of some vehicle delinquency and charge off trends that I found useful. While this data is credit union specific, I cannot go into every credit union’s geographical detail in this article. I will, however, illustrate the importance of doing an analysis on regional data.

Total auto delinquencies and charge offs are on the rise, but much of that may be due to total auto loans increasing at the same time. Looking at the data may calm some concerns or point out where the concern should be concentrated.

For the credit union population as a whole, it appears vehicle delinquency rates, although seasonal, have been almost flat over the last few years. So far, we have not seen the rise in vehicle delinquencies for credit unions. We have, however, seen a rise in vehicle charge off rates as shown below.

Seeing this increase in vehicle charge offs should raise some concern and deserves some further analysis. It is important to look into whether or not this is happening locally as well. Here is the same graph, but I have filtered it by the state of Utah.

In Utah the vehicle charge offs are much flatter, with a slight rise in the used vehicle charge off rate. When I continue to narrow it down to the county level vehicle charge offs even show some decline.

Understanding the trends regionally and how they may differ from national trends helps management to properly serve credit union members. Knowing the regional delinquency and charge offs can be useful in forecasting loan losses, strategy, and pricing.

Going back to the increase in vehicle charge offs nationally, it is important to consider why this may be happening. Is it due macroeconomic conditions? Or is it due to lending practices adopted by credit unions? While we may not be able to see changes in credit scores from call report data, there are some other factors we can look into.

Over the same timeframe as the increase in vehicle charge off rates, the average life of non-real estate loans has been increasing. I have seen many credit unions begin to offer vehicle loans with longer and longer terms. I have even seen one local credit union offer a 9 year auto loan. These longer terms allow for less paydown of the principal each month and may paydown slower than the depreciation of the vehicle. This contributes to collateral risk, where the value of the collateral does not cover the loan principal amount. Another way to assess collateral risk is from loan recovery rates.

As can be seen from this graph, the percentage recovered after a loan is charged off has continued to decline. It also seems credit unions are becoming more willing to lend money on greater than 100% of the vehicle’s value. That carries an inherent amount of collateral risk that could be greatly contributing to the increased charge offs. In contrast, the 1st mortgage recovery rates are increasing dramatically. The increase in housing prices has greatly reduced the collateral risk, at least at the current prices.

Lending practices can have a large effect on vehicle delinquencies and charge offs and may vary from region to region. Reviewing the data trends can give insight into some of the practices that may be contributing to the increase in vehicle charge off rates. The increase may be coming from longer term vehicle loans and lending at above 100% of the value of the vehicle. These practices can be seen as preferential to the member, but may lead to further financial burden. The negative equity the member has in the car also prevents them from being able to purchase a future car. Many times, the negative equity even gets rolled into the next loan which exacerbates and pushes the problem further down the road.

Some of the analysis out there may be deceiving or not applicable to your credit union due to the type of lender or the geography. We have created a new Peer Analysis tool that allows you to customize and filter call report data into meaningful reports for your credit union. It can be filtered geographically, by asset size, and even down to specific credit unions. The graphs in this article were generated from our Loan Loss Peer Analysis tool. We also have Balance Sheet, Income Statement, and Rate Peer Analysis tools. The Peer Analysis suite is easy to use with pre-generated reports and is competitively priced for the smallest of credit unions. The interface is all interactive and accessed online using a username and password. Our goal is to provide every credit union with the ability to have access to meaningful and robust peer analysis reports. We will be launching the Peer Analysis suite at the beginning of 2018. Please let us know if you are interested in more information.

Related/Popular Articles

Jan 14 2021

Five Top Credit Union Topics For 2021

As we move into 2021, the following topics might be worth discussing and considering with your management team.

Earnings

During the first half of 2020, net interest margins came under substantial pressure as market interest rates were shocked dramatically downward. Net interest margins are expected to remain under downward pressure throughout 2021 as investment portfolios continue to reprice lower and share growth continues.

One of the easiest and quickest responses to declining interest income is to address the cost of funds. Many credit unions still have room to decrease their cost of funds, as shown in the September 2020 ending period graph below.

Source: NCUA

Delinquency

Based on the September 2020 call report data, loan delinquencies and net charge-offs remained low and were below September 2019 delinquencies. Loan forbearance and other assistance programs in place through the entirety of 2020 may have helped delinquencies. Also, certain sectors of the economy are not as impacted as others. The unemployment rate is expected to continue drifting lower in 2021. However, as the assistance programs are lifted, delinquencies and charge-offs are expected to increase as unemployment remains substantially above the years leading up to the pandemic.

Source: MHSI Online Peer Analysis Module through September 2020

Credit Union Philosophy

Serving the underserved has always been a hallmark of credit unions, and now more than ever, there is an opportunity to do this for many credit union members. As these times have been challenging, credit unions can continue to evaluate and prioritize how to best serve members in the coming year, especially those under financial stress. Exploring how to provide service to those that are underbanked might be an opportunity. One option may include evaluating risk-based lending policies and programs, especially given the robust liquidity on most credit union balance sheets. New and alternative avenues to bolster income should continue to be explored.

Digital and Technology

As the pandemic shifts and prolongs, credit unions should evaluate if their electronic delivery channels meet members and potential members’ needs. Moving to or improving digital delivery channels should be accelerated and prioritized. Digital delivery should include evaluating loan origination and servicing channels to maximize new loan volumes. Online and remote financial services will continue to grow and may be the preferred way members access and manage their financial activities.

Balance Sheet Growth

Before the pandemic, many experts anticipated credit union loan growth to taper off but remain positive. After the first quarter of 2021, loan production became unpredictable, however, by the end of the third quarter, annualized loan growth was 6.34%. Real estate lending, driven by the abruptly lower interest rate environment, helped with the growth. Experts anticipate loan growth to be around 6.0% to 6.5% over the next 12 months as the economy recovers.

The first few months of 2021 may see strong share growth as the second round of government assistance and stimulus takes hold, and households remain reluctant to spend until signs of COVID easing and warmer weather occur. Share growth last year increased at an annualized rate of over 18% and is expected to be approximately 8.0% to 10.0% in the coming year. If double-digit growth continues, earnings sufficient enough to sustain capital will be critical. If economic conditions improve and overall consumer activity increases, loan growth and increasing long-term interest rates could counter some of the anticipated income pressures. Fortunately, the credit union industry is very well capitalized and able to ride out the adverse conditions and absorb some more growth, even if earnings are reduced.

Nov 04 2020

The Bottom of the Frog Market

Several years back, I went to Mexico for a vacation. While there, I found a ceramic hand-painted frog-shaped planter that I wanted. My husband loves the hunt, and his quest began. Every time we saw a frog-planter, he would start negotiating with the vendor to get the lowest possible price. We searched for several days and would stop in different towns and check the markets while enjoying our vacation and exploring. When we found a frog, he would inquire about the price and negotiate for further discounts. After a few days and no success at getting the cost of the frog below a certain point, my husband declared, “we have hit the bottom of the frog market.”

…

The Bottom of the Frog MarketRead More »

Sep 30 2020

Economic Uncertainties and Interest Rate Certainties – Asset Allocation Assessments and Considerations

Future GDP Projections

In September, the Federal Reserve Chairman spoke publicly on several occasions and reiterated that the central bank is committed to helping the economy “for as long as it takes.” He noted continued improvements in the economy, but also acknowledged a highly uncertain path ahead. The September FOMC (Federal Open Market Committee) projections are now projecting a full-year GDP decline of 3.7%. This is substantially better than their previous expectation of a 6.5% decline. However, they lowered their 2021 outlook from 5.0% to 4.0% and their 2022 outlook from 3.5% to 3.0%. Their 2023 outlook is at 2.50%.

Interest Rates and Economic Uncertainties

The FOMC also indicated that they would allow inflation to run above 2.0% on a sustained basis before any federal funds rate increases. As such, most individual members of the Committee indicated that the federal funds rate could remain close to zero through 2023. Some economists and analysts even think that we may not see an increase in the federal funds rate until 2024 or 2025. They believe that it will take up to five years for the global economy to fully recover to pre-pandemic levels.

The risks to the FOMC economic growth projections are high. Even the Chairman of the FOMC acknowledged the economic uncertainty of the path ahead. Following the sharp rebound in many economic data measures and drop in the unemployment rate, some recent measures have disappointed compared to expectations and some are indicating a recovery that is stalling. At the current time of this article, the nature of further fiscal stimulus continues to be negotiated in congress and some are not expecting a resolution until after the presidential election. Of course this only adds to the current economic uncertainty.

What is highly certain over the short to medium term timeframe is that interest rates will not likely be increasing more than just relatively minor fluctuations in the medium to long end of the U.S. Treasury yield curve. It is more likely that potential risks on the horizon could drive medium and longer-term U.S. Treasury yields even lower.

Reassessing Balance Sheet Strategy

Given the above outlook, it would certainly seem that some credit union balance sheet strategies of recent years should be reevaluated for the foreseeable future. Reassessing asset allocation strategies is possibly more relevant at the current time than at any time in the past several years. For example, the credit union may want to ask itself how much should we be redeploying assets into two to three year investment CDs given current interest rates on those maturities. If the answer is less than previous years, then what are the alternatives we can explore.

Priorities Going Forward

In exploring alternatives, the first priority for credit unions is of course serving members. Assessments and considerations could include expanding the types of loans offered, reevaluating risk based lending allocations, increasing real estate concentrations, debt consolidation programs, and loan payment support alternatives to name just a few. Secondary to the first priority are considerations such as allocations to loan participations and alternative investments. For example, should the credit union assess CUSO or similar investment possibilities. What are all of the possibilities for these type of investments that may be available to the credit union? After all, an alternative of earning five basis points at the corporate credit union with too much of assets is not likely to accomplish any priorities or goals for the credit union.

The present time and foreseeable future is a great time for credit unions to really show how they can serve and support members during these challenging times. Being there for your members is for sure the highest purpose for the credit union and always assessing ways to provide service and assistance to them will always be the credit union’s first priority. In addition and secondarily, now more than any time in recent years it may make sense to really take a deep dive into the above asset allocation assessments, considerations, and possibilities. Ideally, the best answers going forward would combine the first priority with the second to optimize balance sheet performance while best serving members.