Credit Losses Have ‘Normalized,’ Cap One Declares

On the heels of the clarion call from Honda Motor Co.’s U.S. sales chief that lenders are originating “stupid” 84-month loans, Capital One Financial Corp. officials said yesterday that credit losses on auto loans have “normalized.”

Capital One said during its earnings call yesterday that the 7% increase last quarter in its full-year provision for credit losses was “consistent with the gradual normalization of auto charge-offs and allowance builds for auto loan growth.” Capital One said its auto business “remains well-positioned,” however, the company “remains cautious and continues to closely monitor pricing, underwriting practices, used-vehicle prices, and other competitor and market factors.”

Richard Fairbanks, the chairman, president, and chief executive of COF, was asked why the company was somewhat bearish on auto finance, even as it remains “a very strong origination business for Capital One.” His answer is, in our view, the definitive assessment of today’s market:

[W]e’ve been saying the same things for quite a while about the auto business and [that] sort of started with our comments for … the years right after the Great Recession started raging, which is, we went into this kind of — I don’t think it’s exaggeration to call it sort of once-in-a-lifetime kind of confluence of events that led the auto industry, both from the growth and from a kind of returns and credit point of view, to be absolutely exceptional. And most of what we have seen happening since then is sort of a regression more toward normal, if you will. And so, what’s happened, I think, for Capital One and certainly for other players is with each passing quarter, the intensity of the commentary that people in the business make is increased.

But if we pull way up, … we don’t see things that … cause us to have great alarm about the business. But what we see is just on the pricing side increased pressure. … When I look at prime and subprime, that stabilized more recently, but frankly the prime space is … a little bit below cycle norms, so things are very tight there. The subprime space — it’s been steadily declining a little bit … of late.

On the underwriting side, the most noteworthy place that there has been any risk expansion has been in terms of — and there’s been significant growth of — the over-72-month loans. But still things likes LTVs, which is probably the single most important variable, have remained — certainly on the prime side stable — and healthy on the subprime side, moderately increasing, but well below sort of pre-recession levels.

And then Fairbanks offered some advice.

More the way I would characterize this auto business, is that we just have to stay very, very vigilant and what I find is we — our choice is sort of one dealer and one deal at a time — end up with the growth moderating in subprime. For example, subprime has been flat at Capital One … I’m guessing, since 2011, … so that essentially all of the growth in origination has been on near-prime and especially the prime side.

So I think that’s a manifestation of our reaction to the marketplace and continuing to pursue opportunity where it is prudent and where we can build deeper dealer relationships. But I would say the important thing I want to leave with you is, even in new originations, you can see [they] have pound-for-pound kind of a bit higher credit risks than some of the exceptional stuff of the past. The business that we are originating, we still feel is well above hurdle and we like the opportunity.

That “opportunity” turned in 25% year-over-year originations growth last quarter.