Why 2 banks are pursuing margins, not auto loan volume

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At a time when industry watchers are fretting over rising risk in auto lending, two big regional banks are dialing back on auto volume in pursuit of higher-margin business, with one bank shunning risk and raising loan pricing and the other purposely taking on slightly riskier loans.

Notably, Citizens Bank, of Providence, R.I., said it had dropped the “lowest-performing” 10 percent of its dealer network. At the beginning of this year, Citizens said it offered indirect auto loans through 6,800 dealerships — almost entirely franchised new-car stores — in 43 states.

“Tapping the brakes a little bit on our originations and slowing down growth gave us the opportunity to adjust pricing,” Citizens Bank CFO Eric Aboaf said during a conference call last week.

Meanwhile, Fifth Third Bancorp, of Cincinnati, reported lower auto loans outstanding as of the end of the third quarter. CFO Tayfun Tuzun said in a conference call last week that Fifth Third decided to “take down” auto originations and sacrifice volume by way of higher pricing on auto loans and redeploying assets to other consumer sectors, such as mortgages.

Slower growth

Citizens Bank is still growing auto loans outstanding but has slowed its pace. As of Sept. 30, Citizens’ outstanding auto loans were $14.1 billion, just 1 percent higher than they were as of Sept. 30, 2015. The previous year-over-year rise, from 2014 to 2015, was much higher: 15 percent.

Bruce Van Saun, Citizens’ CEO, said that this year the bank has shifted its auto lending focus away from the superprime credit segment, where competition is high and risk and loan pricing are low, to concentrate on the slightly riskier prime segment instead. As a result, charge-offs have gone up, he said, but so have returns, due to the ability to charge prime borrowers higher prices for loans.

“We needed to do that because the reality was that in superprime, you couldn’t make a good return on capital,” Van Saun said during the conference call. He stressed, however, that the company has remained “disciplined” in terms of loan length, deal structure and in staying out of subprime.

Experian Automotive defines the superprime segment as credit scores of 781 to 850 and the prime segment as scores of 661 to 780.

Christopher Wolfe, managing director for Fitch Ratings Inc. in New York, said in some cases banks are shifting assets away from auto loans altogether in favor of other sectors, such as mortgages, where margins are higher.

“Risk-return dynamics are probably not as good” in autos, he told Automotive News on Tuesday. “Terms are getting longer, losses are getting higher, and the concern is: Are you getting compensated for risk?”

Worry over risk

Analysts and some regulators have expressed concern this year about rising risk in auto lending, on top of record volume, with outstanding loans and leases topping $1 trillion for the entire industry.

“Delinquencies on auto loans have begun to increase and used-car values have started to decline. As banks have competed for market share, some banks have responded with less stringent underwriting standards for direct and indirect auto loans,” the U.S. Treasury Department’s Office of the Comptroller of the Currency said in a July report.

Analysts have also been questioning banks about their increased reserves for future auto loan losses, including during third-quarter earnings calls this month. The banks have responded that higher reserves reflect higher volumes and a return to more typical loss levels after a period of record-low losses and record-high used-car values.

Lower targets

Fifth Third said last week its outstanding auto loans as of Sept. 30, 2016, were down 12.5 percent year-over-year to $10.3 billion. That was “in line with our lower origination targets and focus on improving” returns “in this business,” said CFO Tuzun.

“Our strategy so far this year has resulted in higher returns on assets and capital than our initial expectations in our indirect auto business,” he said.

Last year, Fifth Third reached a consent order with the Consumer Financial Protection Bureau and the U.S. Department of Justice that included a lower ceiling on dealer margins on auto loans, plus a total of $18 million in consumer refunds.

Fitch’s Wolfe said it’s “hard to say” whether the settlement had any particular effect on Fifth Third.

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Why 2 banks are pursuing margins, not auto loan volume