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Trends in Auto Sales and Prices: Questions to Consider

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Automakers have been informing investors for months now of a potentially difficult road ahead. Recent articles indicate trends that may present risks or opportunity to your credit union, depending on your situation.

Auto sales have declined the first three months of the year with the current, seasonally-adjusted pace annualizing out to 16.6 million compared to 16.7 million this time last year. Goldman Sachs Group, Inc. is now estimating demand for only about 15 million vehicles in 2017. Compare that to the record of 17.6 million set in 2016. (Source: Bloomberg)

For used cars, the National Automobile17-04-car-row Dealers Association’s (NADA) price index dropped in February by the most since November 2008. Both General Motors and Ford have warned about lower used car prices as many cars come off leases and into the used car pool. (Source: Bloomberg)

Additionally, auto loan delinquencies have increased across all credit tiers causing some lenders to tighten terms or pull back.

As you plan for the remainder of the year and beyond, the list below offers some great discussion topics for ALCO meetings and/or reforecast scenarios to consider:
If auto lending declines, what other avenues are available to us to grow loans? What investment opportunities are available?

  • How might slower-than-expected auto growth impact earnings?
  • If the average used car price falls, how many additional loans will need to be booked in order to meet budget goals? Given our current funding rate, how many more applications would we have to process in order to book those additional loans? How could we process more loan applications without adding expenses related to additional staff or overtime pay?
  • What if we have to dramatically reduce offering rates or increase fees paid to dealers to get the volume?
  • What if credit losses are higher than expected?
  • Are there opportunities that could be created if competition pulls back? Should we take advantage of any such opportunity?
  • How might loan demand be impacted if interest rates rise?
  • What if interest rates rise, putting pressure on us to raise deposit rates, but fierce competition for auto loans leaves us unable to raise loan rates?

The list above is not all inclusive but is a great start. As with most things, there are both opportunities and risks to consider. The sooner you start to consider them, the better off your credit union will be.

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A Few Questions To Consider Regarding Branch Strategy

What is your credit union’s long-term branching strategy?  That might be a tough question to answer for many institutions.  As margins have decreased, many credit unions have had to take a long and hard look at the effectiveness and profitability of their branch network.  While the bulk of new memberships, loans and deposits originate in branches, many institutions have considered shifting toward a model more geared toward e-services.  There are a multitude of questions that could be considered with respect to credit union branching, a few of which are outlined below:

  • How does the branch strategy align with the overall strategic direction of the credit union?
  • Can your institution afford to operate one or more branches that consistently have a negative overall contribution to the credit union?
  • Are branch location decisions based on where your current members live, or where members of your desired target market live?  Answering this question could lead to different decision-making regarding where to position future branch locations
  • Does your institution have the technology to allow for reduced member reliance on branch locations?  If not, how quickly are your technology offerings improving, and at what cost in terms of dollars and resources?
  • What might be the unintended consequences of your branching decisions?
  • How does the credit union measure branch success?
  • If the credit union is moving toward a model that relies less on physical locations, how will your organization effectively cross sell to members or prospective members?
  • Does the strategy fit with the financial realities your organization is facing now, or could face in the next 3 to 4 years, especially if rates remain low and loan demand is slack?
Continued margin pressure is likely to increase the importance and timeliness of these types of decisions.  Meanwhile, members are increasingly asking for more from their financial institutions which makes this a tricky balancing act.
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When Will Loan Demand Pick Up?

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This is the question at the forefront of many people’s minds—particularly as loan balances continue to decline and deposit costs move closer to their floor.  It’s a great question but impossible to answer with certainty.  Since our crystal ball is as cloudy as the next, perhaps a better way to approach the question is to ask it a little differently:  What will it take for loan demand to pick up?

Think back to 2004 and 2005.  What was the economy like?  Where were interest rates, GDP and consumer sentiment?  What was the inflation rate, unemployment rate and personal saving rate?  Finally, what was driving loan growth and the economy during this period?

The housing market was a major driver during this time period.  Unemployment was low, personal saving was negligible (even negative), credit was free flowing and housing construction was rising, all while housing values were rapidly increasing.  Now, let’s consider the housing market today using the graphic below (2010: Housing Recuperates, Celia Chen, Sr. Director, Moody’s Analytics).

Source: Fiserv, FHFA, Moody’s Economy.com

While some areas are in the midst of regaining their value, many others are not and likely won’t be for a long time to come.  As a result, housing may not be the driver of loan growth it once was and could remain a drag on loan growth as consumers continue to deal with the aftermath of the housing bubble.  So we circle back to the question:  What will it take for loan demand to pick up?

This question is a great scenario test drive for management teams to answer together.  The small piece discussed here is just one of the many aspects to consider when discussing this question.  Furthermore, answers to this question will vary depending on your credit union’s community and structure.

However, the objective of this discussion is not just to answer the question.  Rather, it is to consider the implications of the answers with regard to your current strategic objectives and even your tactical, day-to-day decisions.  You may find your direction and outlook to be inadequate in light of the discussions you are having.  If so, now is the time to address those inadequacies and position your institution to be successful in the future.

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Hope For The Best, Budget For Reality

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Recently, during The Economist’s Buttonwood Gathering, Raghuram Rajan, current professor at the University of Chicago’s Booth School of Business and former chief economist at the IMF, expressed concern over our government’s need to address the deficit.  Rajan stated that, “We need to have a path which brings [the deficit] under control.  It’s very important to tell the bond market and the public what that path is.”

Laying out a path to show how we will recover is important.  Not doing so prevents us from addressing the problem which may cause markets to respond poorly, leading to further disaster.

The same logic applies for the credit union world at budget time.  A realistic view of the situation and a path for handling it is the single best tool for dealing with what has been a difficult time for many credit unions.  For example, in some regions loan demand has been very low.  If that same level of loan demand continues, it could make for a tough 2011 for some institutions.

While unfortunate, that is the reality and credit unions shouldn’t “pretty it up” by making assumptions that next year will be better, unless there is reliable data that shows a change in trend.  It is better to present the ugly reality and then identify a series of triggers that can be pulled to make the financial picture bearable.  Only when the board is presented with the reality of the situation can they begin to make the tough decisions that are required.  It may mean settling for losses in 2011 or difficult cuts in expenses but meeting the situation head-on is by far a better alternative than showing a happy budget that will only disappoint in the end.

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Budgeting During Times Of “Unusual Uncertainty”

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Creating a budget is always a challenging and uncertain process.  Developing the annual budget for 2011 may be unusually difficult as there is heightened uncertainty about loan demand, interest rates, investment yields and deposit trends.  Net operating expense concerns include share insurance assessments, threats to non-interest income and provision for loan loss trends—stable, declining, or, for some institutions, still increasing.

Due to this uncertain economic environment, credit unions should consider developing a base budget and then creating multiple scenarios identifying key vulnerabilities that could stress financial performance, such as:

  • What if loan demand continues to be anemic?
  • What if provision for loan loss increases unexpectedly?
  • What if mortgage originations decline materially?
  • What if cost of funds cannot be lowered enough to help offset other adverse scenarios?

Evaluating combinations of negative factors, while depressing, can provide valuable early warning information to management and the credit union’s board.  This process can also help manage key players’ expectations appropriately.

If the base budget is acceptable but there are several plausible scenarios that could create unsatisfactory financial performance, it is good to know this in advance so that decision-makers can begin to think about contingency plans.  This is particularly relevant if the credit union has a level of net worth with very little breathing room.

Identifying the potential problems early on will give your credit union a better chance at making 2011 a financially successful year.  Good luck!