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By: Tom Hannagan Part 1 In my last post about risk-based pricing, we started a discussion of the major elements involved in the risk adjustment of loan pricing. We got down to a risk-adjusted pre-tax profit amount. Not to divert the present discussion too much, but we often use pre-tax performance numbers for entity level comparisons to avoid the vagaries of tax treatments. Some banks are sub-S corporations, while most are C corporations. There are differences in state tax levels and, there may be other tax deferral strategies such as, leasing activity and/or securities adjustments that can affect these after-tax numbers. So, pre-tax data can be very useful. After-tax profit and profitability ratios For internal comparisons across loans, client, lenders and other lines of business; and to better understand how the risk-adjusted profit from a loan or a relationship relate to overall bank performance, we prefer to get to an after-tax profit and profitability ratio. This is also necessary to compare loans or portfolios involving tax-exempt entities to loans with taxable interest income. To do this, we apply the bank’s average effective income tax rate (including federal and state) to the pre-tax result, with the exception of tax exempt loans. This gives us risk-adjusted net income (or profit) at the loan level. By arriving at risk-based profit estimates at the product level, we then have the opportunity to accumulate these for multi-product client relationships, or at lender or market segment levels. Clients can then go on to analyze the profit results in comparison to their distribution of risk ratings and break the risk-adjusted returns down by loan/collateral type, client geography or industry. Some banks have graphical displays of these results. In addition to profit level, and to assist with comparative capability, we continue to one or more profitability ratios. You can divide the profit amount by the average loan balance to get a risk-adjusted return on assets (ROA). ROA = Profit amount Average loan balance This is very helpful for looking at asset product performance and has been used historically by the banking industry for risk-based pricing. Many banks have moved beyond ROA and now focus on return on equity (ROE). For a more comprehensive discussion of ROA and ROE see my post from December 6, 2008. I will continue in my next post about Return on Equity.
Part 2 To continue the discussion from my last post, we also must realize that the small business borrower typically doesn’t wait until we are ready to perform our regularly scheduled risk management review to begin to show problems. While a delinquent payment is a definite sign of a problem with the borrower, the occurrence of a delinquent payment is often simply too late for any type of corrective action and will result in a high rate of loss or transfer to special assets. There are additional pitfalls around the individual risk rating of the small business borrower or the small business loans; but, I won’t discuss those here. Suffice to say, we can agree that the following holds true for portfolio risk management of small business loans: Active portfolio management is a must; Traditional commercial portfolio management techniques are not applicable due to the cost and effectiveness for the typical small business portfolio; and Collection efforts conducted at the time of a delinquency is too late in the process. One last thing, the regulators are starting to place higher demands on financial institutions for the identification and management of risk in the small business portfolio. It is becoming urgent and necessary to take a different approach to monitor that portfolio. Just as we have learned from the consumer approach for originating the loans, we can also learn from the basic techniques used for consumer loan portfolio risk management. We have to rely upon information that is readily available and does not require the involvement of the borrower to provide such information. Basically, this means that we need to gather information (such as updated business scores and behavioral data) from our loan accounting platforms to provide us with an indication of potential problems. We need to do that in an automated fashion. From such information we can begin to monitor: Changes in the business score of the small business borrower; Frequency and severity of delinquencies; Balances maintained on a line of credit; and Changes in deposit balances or activity including overdraft activity. This list is not exhaustive, but it represents a solid body of information that is both readily available and useful in determining the risk present in our small business portfolio. With technology enabling a more automated assessment of these factors, we have laid the groundwork to develop an efficient and effective approach to small business portfolio management. Such an approach provides real- time regular assessment of the portfolio, its overall composition and the necessary components needed to identify the potential problem credits within the portfolio. It is past time to take a new approach toward the proactive portfolio management of our small business loan portfolio retaining the spirit of commercial credit while adapting the techniques of consumer portfolio management to the small business portfolio.
Part 1 In reality, we are always facing potential issues in our small business portfolio, it is just the nature of that particular beast. Real problems occur, though, when we begin to take the attitude that nothing can go wrong, that we have finally found the magic formula that has created the invincible portfolio. We’re in trouble when we actually believe that we have the perfect origination machine to generate a portfolio that has a constant and acceptable delinquency and charge-off performance. So, we all can agree that we need to keep a watchful eye on the small business portfolio. But how do we do this? How do we monitor a portfolio that has a high number of accounts but a relatively low dollar amount in actual outstandings? The traditional commercial portfolio provides sufficient operating income and poses enough individual client credit risk that we can take the same approach on each individual credit and still maintain an acceptable level of profitability. But, the small business portfolio doesn’t generate sufficient profitability nor has individual loan risk to utilize the traditional commercial loan portfolio risk management techniques. Facing these economic constraints, the typical approach is to simply monitor by delinquency and address the problems as they arise. One traditional method that is typically retained is the annual maturity of the lines of credit. Because of loan matures, financial institutions are performing annual renewals and re-underwriting these lines of credit — and complete that process through a full re-documentation of the line. We make nominal improvements in the process by changing the maturity dates of the lines from one year to two or three year maturities or, in the case of real estate secured lines, a five year maturity. While such an approach reduces the number of renewals that must be performed in a particular year, it does not change the basic methodology of portfolio risk management, regularly scheduled reviews of the lines. In addition, such methodology simply puts us back to the use of collections to actually manage the portfolio and only serves to extend the time between reviews. Visit my next post for the additional pitfalls around individual risk rating and ways to better monitor your small business portfolio.
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With the National Automobile Dealers Association (NADA) Show set to kickoff later this week, it seemed fitting to explore how the shifting dynamics of the used vehicle market might impact dealers and buyers over the coming year. Shedding light on some of the registration and finance trends, as well as purchasing behaviors, can help dealers and manufacturers stay ahead of the curve. And just like that, the Special Report: Automotive Consumer Trends Report was born. As I was sifting through the data, one of the trends that stood out to me was the neck-and-neck race between Millennials and Gen X for supremacy in the used vehicle market. Five years ago, in 2019, Millennials were responsible for 33.3% of used retail registrations, followed by Gen X (29.5%) and Baby Boomers (26.8%). Since then, Baby Boomers have gradually fallen off, and Gen X continues to close the already minuscule gap. Through October 2024, Millennials accounted for 31.6%, while Gen X accounted for 30.4%. But trends can turn on a dime if the last year offers any indication. Over the last rolling 12 months (October 2023-October 2024), Gen X (31.4%) accounted for the majority of used vehicle registrations compared to Millennials (30.9%). Of course, the data is still close, and what 2025 holds is anyone’s guess, but understanding even the smallest changes in market share and consumer purchasing behaviors can help dealers and manufacturers adapt and navigate the road ahead. Although there are similarities between Millennials and Gen X, there are drastic differences, including motivations and preferences. Dealers and manufacturers should engage them on a generational level. What are they buying? Some of the data might not come as a surprise but it’s a good reminder that consumers are in different phases of life, meaning priorities change. Over the last rolling 12 months, Millennials over-indexed on used vans, accounting for more than one-third of registrations. Meanwhile, Gen X over-indexed on used trucks, making up nearly one-third of registrations, and Gen Z over-indexed on cars (accounting for 17.1% of used car registrations compared to 14.6% of overall used vehicle registrations). This isn’t surprising. Many Millennials have young families and may need extra space and functionality, while Gen Xers might prefer the versatility of the pickup truck—the ability to use it for work and personal use. On the other hand, Gen Zers are still early in their careers and gravitate towards the affordability and efficiency of smaller cars. Interestingly, although used electric vehicles only make up a small portion of used retail registrations (less than 1%), Millennials made up nearly 40% over the last rolling 12 months, followed by Gen X (32.2%) and Baby Boomers (15.8%). The market at a bird’s eye view Pulling back a bit on the used vehicle landscape, over the last rolling 12 months, CUVs/SUVs (38.9%) and cars (36.6%) accounted for the majority of used retail registrations. And nearly nine-in-ten used registrations were non-luxury vehicles. What’s more, ICE vehicles made up 88.5% of used retail registrations over the same period, while alternative-fuel vehicles (not including BEVs) made up 10.7% and electric vehicles made up 0.8%. At the finance level, we’re seeing the market shift ever so slightly. Since the beginning of the pandemic, one of the constant narratives in the industry has been the rising cost of owning a vehicle, both new and used. And while the average loan amount for a used non-luxury vehicle has gone up over the past five years, we’re seeing a gradual decline since 2022. In 2019, the average loan amount was $22,636 and spiked $29,983 in 2022. In 2024, the average loan amount reached $28,895. Much of the decline in average loan amounts can be attributed to the resurgence of new vehicle inventory, which has resulted in lower used values. With new leasing climbing over the past several quarters, we may see more late-model used inventory hit the market in the next few years, which will most certainly impact used financing. The used market moving forward Relying on historical data and trends can help dealers and manufacturers prepare and navigate the road ahead. Used vehicles will always fit the need for shoppers looking for their next vehicle; understanding some market trends will help ensure dealers and manufacturers can be at the forefront of helping those shoppers. For more information on the Special Report: Automotive Consumer Trends Report, visit Experian booth #627 at the NADA Show in New Orleans, January 23-26.
The automotive industry is constantly changing. Shifting consumer demands and preferences, as well as dynamic economic factors, make the need for data-driven insights more important than ever. As we head into the National Automobile Dealers Association (NADA) Show this week, we wanted to explore some of the trends in the used vehicle market in our Special Report: State of the Automotive Finance Market Report. Packed with valuable insights and the latest trends, we’ll take a deep dive into the multi-faceted used vehicle market and better understand how consumers are financing used vehicles. 9+ model years grow Although late-model vehicles tend to represent much of the used vehicle finance market, we were surprised by the gradual growth of 9+ model year (MY) vehicles. In 2019, 9+MY vehicles accounted for 26.6% of the used vehicle sales. Since then, we’ve seen year-over-year growth, culminating with 9+MY vehicles making up a little more than 30% of used vehicle sales in 2024. Perhaps more interesting though, is who is financing these vehicles. Five years ago, prime and super prime borrowers represented 42.5% of 9+MY vehicles, however, in 2024, those consumers accounted for nearly 54% of 9+MY originations. Among the more popular 9+MY segments, CUVs and SUVs comprised 36.9% of sales in 2024, up from 35.2% in 2023, while cars went from 44.3% to 42.9% year-over-year and pickup trucks decreased from 15.9% to 15.6%. 2024 highlights by used vehicle age group To get a better sense of the overall used market, the segments were broken down into three age groups—9+MY, 4-8MY, and current +3MY—and to no surprise, the finance attributes vary widely. While we’ve seen the return of new vehicle inventory drive used vehicle values lower, it could be a sign that consumers are continuing to seek out affordable options that fit their lifestyle. In fact, the average loan amount for a 9+MY vehicle was $19,376 in 2024, compared to $24,198 for a vehicle between 4-8 years old and $32,381 for +3MY vehicle. Plus, more than 55% of 9+MY vehicles have monthly payments under $400. That’s not an insignificant number for people shopping with the monthly payment in mind. In 2024, the average monthly payment for a used vehicle that falls under current+3MY was $608. Meanwhile, 4-8MY vehicles came in at an average monthly payment of $498, and 9+MY vehicles had a $431 monthly payment. Taking a deeper dive into average loan amounts based on specific vehicle types—as of 2024, current +3MY cars came in at $28,721, followed by CUVs/SUVs ($31,589) and pickup trucks ($40,618). As for 4-8MY vehicles, cars came in with a loan amount of $22,013, CUVs/SUVs were at $23,133, and pickup trucks at $31,114. Used 9+MY cars had a loan amount of $19,506, CUVs/SUVs came in at $17,350, and pickup trucks at $22,369. With interest rates remaining top of mind for most consumers as we’ve seen them increase in recent years, understanding the growth from 2019-2024 can give a holistic picture of how the market has shifted over time. For instance, the average interest rate for a used current+3MY vehicle was 8.0% in 2019 and grew to 10.2% in 2024, the average rate for a 4-8MY vehicle went from 10.3% to 12.9%, and the average rate for a 9+MY vehicle increased from 11.4% to 13.8% in the same time frame. Looking ahead to the used vehicle market It’s important for automotive professionals to understand and leverage the data of the used market as it can provide valuable insights into trending consumer behavior and pricing patterns. While we don’t exactly know where the market will stand in a few years—adapting strategies based on historical data and anticipating shifts can help professionals better prepare for both challenges and opportunities in the future. As used vehicles remain a staple piece of the automotive industry, making informed decisions and optimizing inventory management will ensure agility as the market continues to shift. For more information, visit us at the Experian booth (#627) during the NADA Show in New Orleans from January 23-26.
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typesetting, remaining essentially unchanged. It was popularised in the 1960s with the release of Letraset sheets containing Lorem Ipsum passages, and more recently with desktop publishing software like Aldus PageMaker including versions of Lorem Ipsum.