Community banks are steadily making more auto loans, taking advantage of a surge in demand and low delinquency rates.
The key for many small banks involves finding a niche in their local market, and hiring experienced lenders, industry experts said. Despite relatively strong performance lately, auto lending still carries substantial risk, particularly for community banks that are new to the business.
"If you have a very low, or relatively low, loan-to-deposit ratio and are looking for opportunities, people are still buying cars," said Lynn David, president of Community Bank Consulting Services. "If you can be competitive in your market and end up with a realistic rate on your auto loans, it is something you have to consider."
Outstanding balances for auto loans increased 11% from a year earlier and reached an all-time high in August, at $924.2 billion, according to Equifax. The number of auto loans outstanding rose 6%, to 65 million.
Auto lending at banks with $10 billion or less in assets rose 6% in the second quarter from a year earlier, to $44 billion, according to the Federal Deposit Insurance Corp. Auto loan portfolios at those banks have been on the rise for the past six quarters.
Due to heightened demand, more community banks should consider entering the market or expanding their operations, industry experts said. David said he is working with several small banks that are looking into auto lending because of the potential returns.
Smaller banks "may not have the best technology or the best pricing, but they can make up for that with relationships and good customer service," said Mike Buckingham, senior director of J.D. Power's automotive finance practice. "When dealing with larger lenders, customers have to deal with emails and websites. There is no face of the lenders, unlike the community banks."
Community banks should find a niche, industry observers said. The used-car market is a possibility since it is "easier to penetrate," David said. Smaller banks are also well-equipped to develop relationships with local, independent dealerships because there is so much competition for new loans
The deprecation curve on used cars is "much flatter" than for new cars, posing less risk, Buckingham said.
Community banks could also consider refinancing auto loans, especially for existing clients, said Lou Loquasto, an auto finance leader at Equifax. Doing so would allow smaller banks to work with subprime borrowers, an area that they usually avoid because of the risk.
By refinancing, bankers can review a customer's repayment history, allowing them to offer a lower rate than the original lender. The lender can also take into account situations where the borrower also has an account at the bank.
"This represents a great opportunity for community banks to participate in the growth process with a potentially more proven pool of customers," said Gary Hughes, general manager of automotive services at Equifax. "Banks have the opportunity to look at the whole relationship with the consumer and make some decisions based on that."
Regardless of sector a community bank targets, having a talented and experienced staff is critical, said Terry Keating, an executive vice president at Accord Financial.
Belmont Savings Bank entered auto lending four years ago by hiring a team of lenders that averaged 20 years of experience, including Christopher Downs, executive vice president of consumer lending at the Massachusetts bank. The $1.3 billion-asset bank, a unit of BSB Bancorp, has since built a successful auto lending business by focusing on indirect loans to super-prime borrowers, Downs said.
Belmont's lenders have been able to tap relationships developed with dealerships during their careers to help drive loan growth at the bank, which also sells some of its auto loans to other community banks. At June 30, the bank's auto loans rose 27% from a year earlier, to $118.7 million, according to FDIC data.
"Unless you have the right team and access to the right technology, it can be a very risky business," Downs said. "Any community bank can enter auto lending but it is something you need to have a thoughtful approach about. It is a tough business, and it is easy to make mistakes."
Banks can mistakenly "chase spread as they look for better yields, and they may end up making near-prime or subprime loans when they aren't experienced" in that area, Downs said.
Lenders are warning about intense competition for auto loans. Executives at Huntington Bancshares in Columbus, Ohio, which reported a 32% jump in auto lending in the third quarter from a year earlier, are watching pricing. Huntington remains "focused on pricing discipline," Steve Steinour, the $59 billion-asset company's chairman and chief executive, said during a recent conference call.
There have been warnings of a potential auto lending bubble, especially in the subprime market. But industry experts said a collapse is unlikely in the sector, including subprime loans, which are still below prerecession levels. Delinquencies have started to tick up, but it makes sense given the growth of the subprime market, said Melinda Zabritski, senior director of automotive finance at Experian. Concerns only mount when "lenders aren't planning for an increase in delinquencies," she said.
Still, the warnings highlight the importance of balancing pricing and risk with a desire to make loans, industry experts said.
"In my 20-plus years of being around the industry, this is the most competitive [market] I've seen," Keating said. "It can be a good business but the devil is in the details. You have to know how to underwrite."