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By: Tom Hannagan The problem in the 2005 to 2007 home lending frenzy was not just granting credit to anyone who applied. It was giving loans to everyone at essentially the same price range regardless of normal credit risk scrutiny. While “selling” financial services may be largely an art form, appropriate risk-based pricing is more of a science. Although the financial press seemed to have discovered sub-prime lending in the last year or so, such high-risk lending isn’t new at all. It has been (and is still being) done since finance and money were invented. And, importantly, sub-prime lending has been done profitably by many lenders all along. The secret to their success, not surprisingly, has always been risk-based pricing — even if they didn’t call it that until recent times. Sub-prime funding has been available in many forms and from many sources. Providers range from venture capitalists to pawn shops. It includes pay-day lenders, micro loans, tax refund loans, consumer finance companies, and even dates to Shakespeare’s merchant of Venice. We often hear complaints that the effective rates (prices) on loans from such sources are unfairly high and predatory. The cost of that credit is high, but so is the risk of that credit. Without these kinds of sources, and their high rates, there would not be any credit granted from for-profit sources to high-risk borrowers. Listed firms that regularly provide pay-day loans or cash advances to sub-prime borrowers have very high gross margins and very high credit charge-offs, compared to banks. They also have much higher risk-based capital (or equity) positions that range from 40 percent to 60 percent of their average assets. This risk-based capital burden is much higher than the 8 to 10 percent found at commercial banks. So the sub-prime lenders have a significantly larger capital cushion than banks. Most of these financial results and ratios are examples of successful risk management where the credit risks are identified, managed, priced and backed by sufficient capital. Then…along came the rose-colored greed of the housing bubble that resulted in aggressive building and selling of homes, loan originations to all (no-down, no-income, no-assets, no-problem mortgages), securities packaging and attractive ratings, and global leveraged investing — all by prime-oriented entities and all at prime-oriented prices. Well, obviously, it didn’t work. Risk-based pricing of mortgages would have dissuaded many home buyers to begin with… but what would we have done with all of those shiny new homes? Realistic credit models (that took into account a full credit cycle and a huge proportion of sub-prime credits) would not have rated mortgage-backed securities as AAA. Regulators that were still focused on earnings correctness (the last major snafu) should have been looking into realistic net asset values. And highly compensated investment bankers, with 30-to-1 leverage ratios, would not have gone overboard with intuitively dodgy investments. Few of these players took risk management seriously. The new danger is that banks are doing the whole thing in reverse. They are tightening lending standards — which is, of course, a euphemism for shutting off credit. The danger has nothing to do with so-called credit standards. It’s the general over-reaction of shutting off credit to all borrowers, again, without regard to relative risk. The latest Federal Reserve Board survey of senior loan officers paints a picture of rapid tightening to record levels. We feel that credit standards should always improve AND that loan pricing should always proportionately reflect risk-adjusted rates and terms. Opening the flood gates and then slamming them shut is a very pro-cyclical behavior pattern on the part of bankers that doesn’t reflect a measured approach, borrower-by-borrower, using reasonable risk management at the client relationship level.
One of the more significant operational concerns around Red Flags compliance centers on the management of resultant referral volumes, i.e., the potential that the account origination or maintenance process will get bogged down due to a significant number of red flags detected. These concerns are not without merit, and are arguably the most frequently discussed Red Flag issue with our client base. Organizations may be able to control referral volumes through the use of automated tools that evaluate the level of identity theft risk in a given transaction. For example, customers with a low-risk authentication score can be moved quickly through the account origination process absent any additional red flags detected in the ordinary course of the application or transaction. In fact, using such tools may allow organizations to speed up the origination process for these customers and identify and focus resources on those transactions that pose the greatest potential for identity theft. A risk-based approach to Red Flags compliance affords an institution the ability to reconcile the majority of detected Red Flag conditions efficiently, consistently and with minimal consumer impact. Detection of Red Flag conditions is literally only half the battle. In fact, responding to those Red Flag conditions is a substantial problem to solve for most institutions. A response policy that incorporates scoring, alternate data sources and flexible decisioning can reduce the vast majority of referrals to real-time approvals without staff intervention or customer hardship. Rather than implementing a “rules-based” program (one in which particular Red Flags are identified, detected and used in isolation or near isolation in decisioning), many institutions are opting to approach Red Flag compliance from a “risk-based” perspective. This “risk-based” approach assumes that no single Red Flag Rule or even set of rules provides a comprehensive view of a consumer’s identity and associated fraud risk. Instead, a “risk-based” systematic approach to consumer authentication employs a process by which an appropriately comprehensive set of consumer data sources can provide the foundation for highly effective fraud prediction models in combination with detailed consumer authentication conditions (such as address mismatches or Social Security number inconsistencies). A risk-based fraud detection system allows institutions to make consumer relationship and transactional decisions based not on a handful of rules or conditions in isolation, but on a holistic view of a consumer’s identity and predicted likelihood of associated identity theft. Many, if not all, of the suggested Rules in the published guidelines are not “silver bullets” that ensure the presence or absence of identity theft. A substantial ratio of false positives will comprise the set of consumers and accounts being reviewed as having met one or more of the suggested Red Flag rule conditions. These rules and guidelines are intended neither to prevent legitimate consumers from establishing relationships with institutions nor create a burdensome and prohibitive volume of consumer “referrals.” While those rules incorporated into an institution’s Program must be addressed when detected, a risk-based system allows for an operationally efficient method of reconciliation in tandem with identity theft mitigation.
Whenever an industry encounters problems, the natural tendency is to play the blame game. In the banking industry, credit risk managers are looking for who or what to blame for the tide of charge offs and delinquencies in their under-performing loan portfolios and in their commercial loan origination operations. Credit scoring has definitely taken it on the chin as an easy target during 2008. Is credit scoring the problem? Absolutely not! As with anything, the more complacent we become…and the more we “turn off our brains” and stop thinking…the more risk we assume. The more we solely rely upon the credit score alone, the more we subject ourselves to the risks inherent in “score and go” lending. We are all well aware that credit scoring measures propensity to repay and not capacity to repay. Over the past several years, the propensity to repay has been boosted by ever-increasing real estate values and by the refinance boom. For example, some consumers have been able to survive on a 50 percent debt–to- income due to constant use of credit cards …by paying off those cards with a home mortgage refinance. That set of behaviors would have shown a propensity to repay…but was it ever acceptable to have 50 percent of your income go to debt payments?! Statistically it may have worked for a few years, but once real estate values stopped escalating, the problem with lack of capacity to repay reared its ugly head. When it comes to risk management, let’s get back to reality and sound principles.
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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.