Auto Finance Gains Consumer Credit's Lead Position

An Oracle White Paper

November 2013

Auto Finance Gains Consumer Credit's

Lead Position

Auto Finance Gains Consumer Credit's Lead Position

The Consumer Finance Market: Where We Are ................................ 2

Leading Factors: Economics, Regulations, and Risk ..................... 2

Regulations and Regulators .......................................................... 3

Risk ............................................................................................... 3

Opportunities and Challenges ........................................................... 4

Auto Finance Returns .................................................................... 5

Why Auto Finance? Because Consumers Are Buying It ................ 6

Consumers Breathe New Life into the Used-Car Market................ 7

Hard Lessons Learned from Leasing ............................................. 8

It Really Is Hard to Tell the Challenges from the Opportunities ...... 8

Technology Can Help ........................................................................ 9

More Work and Lower Returns ...................................................... 9

Is Straight-through Processing the Answer? ................................ 10

Are We There Yet? .......................................................................... 11

Recommendations....................................................................... 11

About Oracle Financial Services ...................................................... 12

About Aite Group ............................................................................. 12

Auto Finance Gains Consumer Credit's Lead Position

The Consumer Finance Market: Where We Are

The U.S. consumer credit portfolio is hemorrhaging loan balances at a never-before-seen rate. Since

2008, when loan balances totaled US$13.7 trillion, more than US$1 trillion has vanished from the

portfolios of regulated financial institutions that earn much of their revenue from interest and fees on

loans. Every product portfolio shown in Figure 1 lost billions of dollars in balances in less than five

years. Some products, such as mortgages and home equity lines of credit (HELOCS), will take many

more years to recover (if ever they do), student loans will never recover, and credit card and small

business loans will also languish. Auto finance is the only market to date to show signs of recovering as

new auto sales continue to grow and balances increase with them. Most noticeably to blame is the U.S.

economy¡ªhowever, there is more to it than that.

U.S. Consumer Loan Balances by Loan Type, May 2013. (N=US$12.7 Trillion)

Other

Student loans 6%

4%

Credit cards

5%

Auto finance

6%

Small business

5%

Mortgage

68%

HELOCs

6%

Figure 1: Decline in Consumer Loan Balances Exceeds US$1 Trillion in Less Than 5 Years

Sources: Aite Group analysis of data from Federal Reserve, SBA, Department of Education, and other industry

sources

Leading Factors: Economics, Regulations, and Risk

The U.S. economy has been in the midst of an economic hard landing for some years now.

Unemployment remains unacceptably high, permanent job loss continues to be estimated at 15 million,

while geopolitical gridlock, threats of a euro zone implosion, and the effects of a burgeoning U.S.

national debt are key contributors to consumers' distress. Other factors include:

?

Natural disasters such as tornadoes, hurricanes, and wildfires, whose impact and geography cannot

be predicted

?

Rising energy costs

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Auto Finance Gains Consumer Credit's Lead Position

?

Falling housing prices and financial markets

?

Fragile new auto sales

?

Obama care (the latest threat to businesses and retirees)

Consumers do not feel good about their financial health. They fear losing their jobs, homes, savings,

and retirement. When consumers are afraid, they stop spending and borrowing. In turn, the ¡°good¡±

consumers pay down their balances. These factors, in addition to government-induced low interest

rates, have caused a significant loss of revenue and deterioration of credit businesses' performance.

And while the good consumers are paying down their balances, others are not paying their bills at all,

thus thrusting much of the credit portfolio into serious delinquency. Loan balances have been written

off at very high levels over the past few years. At the same time, the numbers of loan accounts that

financial institutions must manage do not disappear nearly as fast as the portfolio balances. That they

must manage these loan accounts without financial support from new account revenue seriously

impacts banks' and credit unions' financial returns.

Lately, IT has provided little help in driving processing costs down. In normal times, institutions would

manage debt collection with help from IT and operating resources. Unfortunately for most banks,

credit unions, and finance companies, these resources are busy with regulatory compliance and thus

unavailable.

Regulations and Regulators

Since 2010, the Dodd-Frank Act has been wreaking havoc on regulated institutions, whether through

mandating massive rule revisions that no one regulator wants to own or introducing new regulators

struggling to position their agency as authorities but uncertain as to how to approach the role.

Institutions bristle at the lack of direction and clarity from regulators. All the document changes,

confusion, and new ¡°guidance¡± continue to distract lenders from their customer focus and inhibit their

ability to grow portfolios. Meanwhile, the newest regulator¡ªthe Consumer Financial Protection

Bureau (CFPB)¡ªseems determined to revisit past concerns, such as indirect auto finance, mortgage

servicing, and collections, adding to lenders' uncertainty, depleting resources, and threatening the auto

finance ecosystem.

Most importantly, uncertain compliance requirements and tighter compliance deadlines impact IT and

operations resources trying to implement new rules and guidance, which significantly adds to the

lender's costs. Lenders high on regulators' ¡°most troubling¡± list do not have the resources to comply,

help improve processing, and move ahead with growing their businesses.

Risk

It is for all of these reasons that compliance and regulatory risk emerge as the top concern among all

leading lenders in a recent Aite Group survey of executives from top lending institutions. Figure 2

shows that 95% of respondents believe that compliance and regulatory management is highly

challenging. Interest rate risk (particularly in mortgage and HELOC lending) along with credit and

liquidity risk also head challenge lists.

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Auto Finance Gains Consumer Credit's Lead Position

Q. How Challenging Will These Issues Be for Credit Managers During the

2013-to-2015 Period? (N=20)

Compliance and

regulatory

35%

Interest rate risk

40%

Credit risk

20%

5%

Liquidity

20%

5%

Very challenging

60%

10%

Extremely challenging

Figure 2: Top Lenders Gravely Concerned About Compliance and Interest Rate Risk

Source: Aite Group survey of 20 credit executives from top 50 U.S. lenders, February to June 2013

Lenders do tell us that moving forward they believe credit risk is much more manageable and in fact

under control. However, Aite Group believes that competition, especially the convergence of new

players in the marketplace, could radically change that. It could also lead to unflattering service

comparisons and lost opportunities.

As an example, Quicken Loans is a mortgage finance company that built its business on its speed of

delivery and frequent customer communications, and it topped J.D. Power's customer satisfaction

survey for three years running. In the auto finance space, Ally Bank (formerly GMAC) lowered its fund

costs by taking in US$45 billion in deposits and loans for its bank. It also provides application

processing support for multiple captive finance companies, and it originates its loans online.

And because of growth in new-car sales, banks that had previously left the indirect auto business have

returned to the marketplace. Other banks with leading share in financing new- and used-car sales at

dealerships launched subprime subsidiaries to capture more profitable and higher-risk loans. This

moves the capital risk offline and allows the lender to provide a convenient credit resource to the

dealer.

Increased competition for new customers can push lenders to take inadvisable risks with credit

products, policies, or pricing. It is more prudent to learn from competitors and, in particular, to look at

how they leverage technology for flexibility and speed in delivering products and services. Competing

with aggregators? Think like them.

Opportunities and Challenges

What is clear from all this is that in the credit market opportunities and challenges can be difficult to

distinguish. There are possibilities for growth in three different product segments:

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