TCF’s auto book is driving profit — but at what cost?

Wait — how risky are those auto loans you just put on your books?

That was the big question facing TCF Financial executives Monday as analysts peppered them with questions about the effects of the Wayzata, Minn., company’s strategy to hold more auto loans for investment.

During the second quarter, the average yield on TCF’s auto-loan book rose nearly 100 basis points from a year earlier to 5.01%. The increase stemmed from the company’s recent decision to pull back on auto loan sales and securitizations amid investor fears of risk-taking by lenders. On April 1, about $345 million in auto loans — mostly given to borrowers with blemished credit — were moved onto the company’s books, after previously being categorized as held for sale. Yields are calculated off of loans categorized as held for investment.

The idea behind holding more auto loans, rather than selling them off, had been to boost profitability and minimize swings in quarterly results. When TCF announced the shift in strategy in April, during its first-quarter call, executives said they expected to move down the credit spectrum — and get paid for taking additional risks.

But the spike upward in average yields still managed to raise eyebrows, as analysts on Monday pressed TCF executives several times — and in several different ways — for more details about the credit profile of the new auto loans on its balance sheet.

“I would say that how we look at it is more near-prime in nature than subprime,” said Mike Jones, head of consumer banking. “I mean, we don’t really do any deep, deep subprime. So if you look at that portfolio kind of on an average standpoint, it was probably more near-prime than subprime.”

Ken Zerbe, an analyst with Morgan Stanley, pointed out that yields on the recategorized loans “would have to be insanely high” in order to so sharply boost the average yield on TCF’s $3.2 billion-asset auto portfolio overall.

“The assets or loans that were sitting in held for sale were higher yielding assets — probably our highest-yielding assets,” Jones said in response.

TCF declined to disclose details about the average FICO score in its auto book. As of March 31 — before the $345 million in auto loans were recategorized — the average credit score in the portfolio was about 732.

As part of its shift in strategy, the company expects to devote as much as 15% of its auto book to loans with FICO scores as low as 600, David Chiaverini, an analyst with Wedbush Securities, wrote in a research note Monday.

The bevy of questions illustrated the some of the lingering concerns with TCF's car-lending business.

TCF entered the auto business after the financial crisis, when car sales started booming. The business quickly became a fee machine for the now $22.1 billion-asset company, which sold off a significant portion of its higher-risk, higher-return originations to the secondary market.

But when gains on the sale of auto loans took a dive at the end of 2016, as investors raised concerns about looming credit risks, TCF changed its focus. Rather than selling auto loans, the company decided to keep more of them on its books.

The shift was evident in the company’s second-quarter results: Auto originations fell about 40% from the prior quarter. Total auto loans held for investment, meanwhile, rose 17%.

As of June 30, auto loans accounted for about 18% of TCF’s loan book, though that figure is expected to decline to about 15% over time.

“We are confident about the changes we are implementing, and the positive impact they will have on the organization moving forward,” said Craig Dahl, chairman and CEO.

Whether or not the shift in TCF’s auto strategy will boost profits down the road remains to be seen. Executives emphasized that they are focused on getting paid for the risks the lender is taking in the auto business, where it is mostly a used-car lender.

Still, company executives expect net chargeoffs in the auto business to “increase modestly” over time, given the shift to lower credit scores. During the second quarter, chargeoffs as a percentage of loans were 0.83%, or 14 basis points higher than a year earlier.

The average yield on the company’s auto portfolio, meanwhile, is also expected to increase as well.

“We expect to maintain a meaningfully higher risk-adjusted yield with our originate-to-hold strategy,” Dahl said. “Overall we are pleased with the performance of the business and like the outlook of the business model going forward."