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84-Month Loans Focus of New Black Book Analysis

by Auto Remarketing:

Black Book Lender Solutions wanted to give the industry analysis and information so dealerships and finance companies can handle the latest origination challenge.

A potential buyer has a family budget cap for a monthly payment of roughly $400, but those stipulations demand that the vehicle installment contract term stretch to 84 months to get the unit delivered.

On Friday, Black Book made its latest white paper available that's appropriately titled, Collateral Insight Critical to 84-Month Auto Loans. Barrett Teague, Black Book's vice president of lender solutions, told SubPrime Auto Finance News that 10 years ago, a term of "84 months was really not a topic of conversation."

What Teague described as "specialty shops" handled the longest term loans that usually peaked at 75 months and were reserved for "pristine" customers.

Now with terms stretching to 84 months moving from talk at industry conference networking sessions to contracts connected to metal on the street, Teague insisted Black Book "addressed something we don't feel is being addressed very often in the marketplace today when it comes to those longer-term vehicles."

Of course, it doesn't take a seasoned finance company executive to realize the risk increases the longer the term is. Black Book outlined in the white paper four considerations when determining risk levels, including

• LTV ratio

• Rate of vehicle depreciation

• Credit profile

• Risk adjusted return on capital

"This kind of analysis will help the lender review the loan deals from a whole-lifetime-analysis perspective so they can optimize their risk and return for that portfolio while at the same time meeting their customer needs," said Anil Goyal, Black Book's vice president of automotive valuation and analytics.

Goyal and his team gathered the data and found not only a variety of vehicle depreciation trends from Black Book's own resources, but also referenced material from government outlets as well as Experian Automotive.

As elaborate as all of the data points can possibly be, Black Book boiled down one crucial component that might be one of the most important triggers of the rise of 84-month contracts. According to the U.S. Census Bureau, from 2007 through 2012, household incomes rose just 1.6 percent from an average of $48,729 to $49,486.

However, during that same time, the average price of a 2- to 6-year-old vehicle rose 24.9 percent from an average of $11,160 to $13,949, according to Black Book vehicle valuation data.

"It becomes very apparent there's not a lot more household income to spend on vehicles, yet the consumer is spending more each month on that. That's really the driving the consumer need on the longer-term loans," Teague said.

In light of consumer demand, Goyal explained that captives, banks, credit unions and even buy-here, pay-here dealerships with related finance companies might ask themselves as series of questions when deciding how far they want to stretch terms to meet consumer demand.

"How much longer are you going to keep that vehicle in a negative equity situation, which is going to increase that severity of risk?" he said. "What is the value today? How much loan do you want to lend? When is that loan going to turn around into a more positive situation? How is that collateral going to perform? What are the depreciation trends?

"Analysis of collateral values becomes very important," Goyal continued in Friday's conversation with SubPrime Auto Finance News.

Teague pointed out that some finance companies are looking to leverage the possibilities of longer terms to increase potential profitability. Because interest rates are low for consumers with strong credit background, Teague noted shorter terms aren't allowing for an extended window for the portfolio to blossom.

"Instead of just increasing the risk based on credit score alone, that there is an opportunity based on the term that's out there," Teague said.

But as Black Book also mentions in the white paper, longer terms create a potential sour consumer situation down the road depending on how long the buyers wants to keep that vehicle.

"There is always a place for longer-term loans. There is a customer out there who would really benefit," Goyal said. "If that customer is intending to keep that vehicle for seven to eight years and not looking to come back to the dealership in three to four years, this is an ideal loan for them. But if that customer is looking to come back in three years, they're going to find that they don't have much value for that trade-in, and it's going to be a difficult conversation when they come back.

"I think it's important for the industry to recognize that there is a place but it depends on how you target them … making sure you're addressing the right segment for that customer and getting them into the right vehicle that makes sense for this longer-term loan.