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Industry fine-tunes credit measures to avoid subprime risk

The idea of a subprime auto loan bubble still hasn’t popped with everyone.

Thomas Curry, comptroller of the currency, made that clear last week in remarks to the Exchequer Club, a group of professionals from trade associations, federal regulatory agencies, law firms, congressional committees and the national press in Washington.

Curry, echoing other finance industry watchers, said the status of auto lending today resembles what happened in the mortgage industry in the run-up to the financial crisis.

Considering the economic losses to businesses and consumers as a result of the crisis, the concern is understandable. Nevertheless, skeptics should weigh the effects of work being done by dealers, lenders and credit bureaus to prevent an auto-lending-driven downturn and burst the notion of the subprime bubble.

With longer loan terms and high subprime loan volume, Curry said, borrowers are in negative-equity positions longer, which could lead to losses for lenders. He also projected that the currently low delinquency rates could rise.

“How these auto loans, and especially the nonprime segment, will perform over their life is a matter of real concern to regulators,” he said. “It should be a real concern to the industry.”

Chris Kukla, senior vice president for the Center for Responsible Lending, held a similar opinion in an April Automotive News column. “We should ensure that loans are not made unless the borrower’s ability to repay is fully taken into account. Otherwise we risk creating needless economic harm,” he wrote.

But auto industry insiders call the subprime bubble a myth, noting that while subprime auto lending is going up, subprime borrowers are paying their loans.

For example, Raj Sundaram wrote in an April Automotive News column that today’s auto-lending conditions “bear virtually no resemblance to the mortgage issues that precipitated that fateful bubble.” At the time, Sundaram was co-president of Dealertrack. Cox Automotive acquired Dealertrack this month, and now Sundaram is chief client success officer for Cox Automotive.

“Since car sales to all credit sectors have soared, it’s only natural that subprime would recover along with the overall industry,” Sundaram wrote, adding that subprime lending is growing at about half the rate of prime lending.

Measuring customers’ payment ability

Approving loans that will be paid back is on the forefront of lenders’ minds. Wells Fargo CFO John Shrewsberry this month described the lender’s 7 percent increase in third-quarter auto loans as a reflection of a healthy auto market but added that the bank is remaining “disciplined” in its lending approach.

Many lenders, dealers and credit bureaus, looking to make sure the notion of a subprime bubble stays a myth, are working to better measure customers’ ability to repay their auto loans.

For example, Equifax has access to employment data from 75 percent of all Fortune 500 companies, Lou Loquasto, Equifax’s auto finance leader, told Automotive News last year. Lenders and dealers use the data to verify consumers’ income and employment and estimate their ability to stay on top of their loan payments, he said.

TransUnion also considers factors beyond consumers’ credit scores. This month the credit bureau announced the rollout of a new program that takes customers’ payment history, in addition to credit score, into account when lenders make loan approval decisions.

Right car at the right price

It behooves dealers and lenders to put consumers in the right car at the right price with a manageable loan and payment plan.

Some dealerships, Driver’s Village in Cicero, N.Y., for example, prescreen customers to better align them with vehicles they can afford, “so that they don’t find out that, based on the credit score, the car is a bad fit,” Firas Makhlouf, the dealership group’s chief information officer, told Automotive News this month.

With 700 Credit’s prescreen tool, “we try to find the right bank and the right vehicle” and consider the loan-to-value ratio with the payment-to-income ratio and credit score, he said.

Thomas Dundon, former CEO of Santander Consumer USA, told Bloomberg in July that he is surprised by the subprime scrutiny.

“There’s a lot of people in the world that are in different situations and the fact that this industry has become very efficient and helps people keep their costs down to get something that a lot of us take for granted, I think that's a good thing,” he said. “Unfortunately it seems to be painted as something bad, and I’m not sure why.”

As lenders and dealers forage for information to match consumers with the right vehicle and to make educated lending decisions, let’s hope their efforts are paying off, so we can stop debating the existence of the subprime bubble.

You can reach Hannah Lutz at hlutz@crain.com

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