Bank of America (BAC.N) is making a big push into auto lending just as regulators are sending warning signals, losses from auto loans are rising, and rivals are growing more cautious after years of strong returns.
The bank tapped mortgage executives Matt Vernon and John Schleck to lead the auto lending business last May, saying they would be able to sell auto loans alongside other products such as checking accounts and home equity loans.
In interviews, the executives and their boss, D. Steve Boland, who oversees a broad swath of consumer lending, said they still see room for growth from borrowers who have good credit. They have hired extensively in recent months, adding dozens of loan officers and salespeople.
But some competitors and bank analysts said hiring doesn’t make sense at this stage, because auto sales may be close to peaking, and consumer credit is showing signs of weakness.
Industry-wide, banks classified $1.1 billion worth of auto loans as uncollectible in the fourth quarter, according to the Federal Deposit Insurance Corp. That is up 15 percent from the year-ago period, and up 39 percent since the fourth quarter of 2011. Ultimately, much of that bad debt turns into losses for the banks.
For a graphic showing auto loans that are 30-89 days past due and an auto sales projection, see tmsnrt.rs/24xv9vV
“I’m not actively hiring or growing our operations across the platform. That’s for sure,” said Andrew Stuart, head of TD Auto Finance, which is slightly smaller than Bank of America’s auto business
At a Feb. 10 conference, Capital One Financial Corp (COF.N) CEO Richard Fairbank said that while auto loans provided “once in a lifetime type returns” after the financial crisis, the business has begun to lose strength. In a January interview on CNBC, JPMorgan CEO Jamie Dimon called the market “stretched.”
Portales Partners analyst Charles Peabody said Bank of America is late to the auto loans party. But in its defense, he noted that the bank’s Chief Executive Brian Moynihan and his management team were too busy trying to resolve mortgage-related issues when the auto lending business seemed like a smarter bet.
“They should have been beefing this thing up two years ago, but two years ago Moynihan was still trying to stabilize the ship,” Peabody said.
All banks are struggling to boost revenue during a period of stubbornly low interest rates and tough post-crisis regulation, but Bank of America has felt the pain more acutely than most of its peers.
The second-largest U.S. bank by assets, Bank of America trades at just 50 percent of book value, compared to 90 percent for JP Morgan Chase & Co (JPM.N) and 130 percent for Wells Fargo & Co (WFC.N). Bank of America took bigger losses than those rivals during the crisis, and still lags them by other key metrics, including return on equity and costs in relation to revenue.
While Bank of America showed some progress in 2015, it still has to prove it can generate consistent performance under Moynihan, who took the helm in 2010. During his tenure, the bank has paid tens of billions of dollars in fines and settlements related to mortgages that were issued before he became CEO.
Bank of America ranks 11th among U.S. auto lenders, with just 1.72 percent of the market in the third quarter of last year, according to the latest available data from Experian Automotive. Ally Financial Inc (ALLY.N), the largest U.S. auto lender, accounts for 6 percent, followed by Wells Fargo, which ranked second with 5.57 percent. JPMorgan was fifth with 4.15 percent.
Bank of America may rank higher on Thursday, when Experian says it will release fourth-quarter data, because Vernon said much of its growth came at the end of the year.
Auto sales remain very robust. Figures carmakers released on Tuesday showed that sales climbed to a 15-year high for the month of February, driven by low gasoline prices, wage growth, and because loans are both available and cheap. But most forecasters expect sales to peak in 2016 and trend down over the next few years.
“We remain in the ‘plateau’ camp,” RBC Capital Markets analyst Joseph Spak wrote on Tuesday, sticking to his flat sales forecast.
Stocks have broadly declined in recent months over concerns about the global economy, and some companies that make money selling or financing vehicles have gotten hit even harder. They recovered some of those losses after the latest sales figures.
Ford Motor Co (F.N) and General Motors Co (GM.N) are down roughly 6 and 11 percent, respectively, since the beginning of the year, while publicly-traded auto lenders Santander Consumer (SC.N) and Ally are down 35.7 percent and 2.8 percent, respectively. The S&P 500 Index .SPX has dropped 2.8 percent so far this year.
Delinquencies on bonds comprised of subprime auto loans hit their highest level in six years, Fitch Ratings said last week. According to the FDIC, 1.82 percent of all auto loans were 30 to 89 days past due during the fourth quarter – the highest rate on record since the FDIC began keeping track in 2011.
As weakness in the auto sector has become evident, regulators have begun to sound alarm bells.
In a speech in October, U.S. Comptroller of the Currency Thomas Curry warned of risks from subprime auto loans, as well as loans that mature in six years or more, which tend to be issued to customers who can’t afford monthly payments on loans with shorter durations. In November, the Federal Reserve Bank of New York issued a report on auto lending that showed a growing portion of loans being issued to consumers with poor credit.
FOCUSED ON PRIME
Bank of America says it is focused strictly on prime and “superprime” customers. The “majority by far” of its auto borrowers have credit scores higher than 700, Vernon said. Borrowers with credit scores above 660 are generally considered to have good credit.
Still, a decline in used car values would lower recoveries on loans that go bad, and the longer the life of the loan the greater the exposure to such a risk. Bank of America will lend up to 75 months — slightly longer than the six years Comptroller Curry cited as a concern — though Vernon said the average maturity is far lower.
The bank does not release granular data on its auto loan book, so it is hard to know how its borrowers’ credit quality has held up over time. In data provided to Reuters, Bank of America said it made $23.7 billion in auto and recreational vehicle loans in 2015, up 41 percent from 2014.
Most of that growth came through auto dealers, the area Vernon oversees, and much of it happened in the fourth quarter after he hired seven “relationship managers” whose job is to drum up business with dealerships around the country. Vernon is targeting 5-10 percent growth for his operation in 2016.
Schleck, who oversees the business that works directly with retail customers, has also been staffing up — nearly doubling the number of loan officers to 110 from 60 since last May. Although Schleck said he is unlikely to continue growing staff at that pace, he may hire more this year if demand warrants. Likewise, if demand cools, Schleck said he is prepared to reduce staff.
“I needed to get to a certain level to be able to provide a certain level of service and I needed to get there very quickly—and did,” he said. “Prior to May there was probably a lot of lost opportunity, whereas after May, I’m capturing what maybe we could have captured earlier.”
Boland, their boss, said it’s true that Bank of America was “in a different place in 2012,” but disputed the idea that the bank is too late to build up its auto loans business.
“I don’t feel like I’m late at all,” he said. “There’s not a timing issue to it. I’m going to continue to focus on growing across our consumer lending.”
As long as the bank is cautious about borrowers and keeps staffing in line with demand, it can grow just by selling to more of its existing customers, Boland added.
Patrick Kaser, portfolio manager at Brandywine Asset Management, which owns about 26 million Bank of America shares, said the bank’s strategy is sensible even if it comes at a less-than-optimal time. The bank pulled back “far too much” from certain businesses after the shock of its mortgage losses and fines, and re-entering the market with a focus on healthy consumers makes sense, he said.
“Only time will tell if they’re entering at the peak and whether or not they’ll be too aggressive,” said Kaser, “but the banks have a lot of incentive to show discipline.”