Amid rising interest rates and ebbing light-vehicle sales, TD Auto Finance is expanding its U.S. auto lending portfolio beyond its longtime niche of superprime new-car buyers.
The lender, a division of Toronto-based TD Bank, is still focused on the top-tier customers whose FICO scores are 760 and higher, but it is pursuing more used-car volume and is dipping deeper into the credit pool by lending to more prime and near-prime borrowers, said Senior Vice President Chris Howard.
Near-prime customers have accounted for much of TD Auto Finance's 4.9 percent U.S. lending growth since May 2016. Loans to near-prime borrowers, those with FICO scores of 620 to 680, jumped 44 percent, and loans to prime borrowers rose 12 percent.
TD Auto Finance hasn't changed its lending philosophy, said Howard, head of the lender's U.S. product group. But it is adjusting to new opportunities as other lenders tighten credit standards and retreat to safer credit pools in reaction to a shifting auto market and U.S. economy.
The long period of extremely low interest rates that supported expanding U.S. auto sales between 2010 and 2016 is ending, and the Federal Reserve has told financial markets to expect a gradual rise in core interest rates as the U.S. economy continues to improve. The Fed increased interest rate targets another quarter-point at its June meeting.
Auto lenders have taken advantage of cheap capital in recent years to offer inexpensive auto loans and leases. Automakers in particular through their captive lenders have used the low cost of money to offer subsidized lease deals with low monthly rates, typically with manufacturers and captives sharing the subsidy costs.
As interest rates rise, so will the cost of money for auto lenders, including commercial paper and securitized bonds. But TD Auto Finance expects less volatility in its source of capital.
"Our funding is depository," Howard said. Parent TD Bank, the fifth largest North American bank, has 24 million retail depositors in the U.S. and Canada.
Howard declined to call that a strategic advantage, characterizing it instead as stabilizing. He doesn't expect abrupt changes in interest rates. In a June advisory, TD Bank Chief Economist Beata Caranci said the Fed is likely to raise interest rates just a quarter point by year end.
Despite first-half growth rate volatility, "the U.S. economy is progressing," she said. "Growth is on track to reach its cruising altitude of 2.2 percent and maintain a similar outcome in 2018."
In keeping with TD Bank's cautious approach, Caranci excluded expectations of any government financial stimulus in her 2017 analysis. She thinks the prospects that Congress will pass tax reform this year "are dimming" and that the U.S. government still might shut down at the end of September. And as the economic cycle matures, pent-up demand for autos and other big-ticket items "is increasingly sated."
Despite that, Caranci expects enough growth that the Fed will continue raising rates, with the funds rate reaching 2.25 percent by the end of 2018.
In that environment, Howard said, TD Auto Finance sees opportunity in more used-vehicle loans, especially in certified pre-owned, and a mix of superprime, prime and near-prime customers. In 2015 TD Auto Finance was almost exclusively focused on superprime customers. "But this year we are running about 50 percent prime, 15 to 18 percent near-prime and the balance superprime," Howard said.
He said new-vehicle lending remains a good business for TD Auto Finance — "still a good place to be in" — even if U.S. volume were to decline to 17 million vehicles this year.
Despite its origins as a captive lender — Toronto-Dominion Bank completed the purchase of Chrysler Financial in 2011 and renamed it — TD Auto Finance has no interest in re-entering the leasing business. "We leave that to the captives," Howard said.
TD Auto Finance has a different profile since TD Bank took over, serving franchised dealers of all brands across 50 states. Experian ranked it No. 15 among independents and captives in total number of U.S. auto loans and leases in 2016, with a 2.48 percent market share.
But Howard wants more used-vehicle business as the number of late-model used vehicles returning to dealerships surges. So far this year, TD Auto Finance's lending mix is 40 percent used.
He's especially keen on the growth of the certified pre-owned business. TD Auto Finance has noticed that the credit profile of buyers willing to pay a premium for low-mileage and reconditioned CPO vehicles is much closer to new-vehicle buyers than typical used buyers. That puts more CPO customers on TD Auto Finance's radar, he said.