Sharpening Decisions: Lenders Have Been Forced to Hone Choices Amid Intensifying Opportunity Risk | Auto Finance News | Auto Finance News

Sharpening Decisions: Lenders Have Been Forced to Hone Choices Amid Intensifying Opportunity Risk

When Hyundai Capital America entered the subscription space in April 2017, several OEMs were already offering an all-in-one monthly price for lease payments, maintenance, and insurance. Fast forward a year, and Hyundai has increased prices on its subscription service and is evaluating whether to expand the scope of the program.

“We don’t know what the future looks like, but we know subscriptions could be one of the solutions,” HCA Chief Risk Officer Marcelo Brutti told attendees at the Auto Finance Performance & Compliance Summit. “So we want to get experience out there, we want to see how the market reacts, we want to put it out as a potential product.”

The program is currently available only in California, but Hyundai is considering launching it in other states, a decision that requires the captive to carefully weigh the pros and cons that come with a new product launch. Done correctly, the risk could yield high reward.

“You have to identify all of those risks before you actually decide to launch a new product,” Brutti said. “Even after you do all that, you have to decide whether you actually want to do it. What are the implications if you do it? And what are the implications if you don’t do it?”

That opportunity risk — the probability of loss that arises when a company irreversibly devotes resources to an opportunity and then a better one presents itself — has been growing in prominence. In a nutshell, opportunity risk boils down to a risk not taken. It can take years for a company to shift gears and chase a new opportunity, but by then competitors will likely already have had a head start.

The auto industry has experienced plenty of changes in the past few years, with the rise of subscription models, car-sharing, electric vehicles, and direct lending services. Each of these innovations has its own risk factors that companies need to consider. Is the innovation a fad? Is it worth investing in the technology? Could this be its own business? A miscalculation on any of these fronts could lead to wasted money and time that could have been spent on other resources.

From a compliance perspective, the landscape is filled with question marks following the leadership shakeup and changing regime at the Consumer Finance Protection Bureau. Should lenders shift more focus to call-monitoring systems in the wake of the alterations made to the Telephone Consumer Protection Act or should they increase staff in the customer service department? A slip in compliance could lead to fines, poor reviews, and bad publicity, so the way opportunity is measured could have lasting consequences.

Compliance Risk

In 2016, the Consumer Finance Protection Bureau bound three lenders — American Honda Finance Corp., Fifth Third Bank, and Toyota Financial Services — to consent orders to cap interest rate markups at 150 basis points as a part of an industrywide guideline. The rule was derided by the industry and in May, the consent order was lifted and enforcement of the guideline was rolled back.

Less than a month later, Toyota Financial’s consent order was approved for early termination, spurring the lender to bump up dealer rate caps to 2% for terms up to 72 months, and up to 1.5% for 84-month loans, a company spokesman told Auto Finance News at the time.

“Modification of our dealer participation rate caps will enable us to continue serving the best interests of our customers while allowing us to remain competitive in the marketplace,” the spokesman said. “It is important to reiterate that we do not tolerate discrimination of any kind, even perceived or unintentional. This principle extends to fair
lending practices.”

Had Toyota stayed in the consent order for the full three-year term, it would likely have faced a competitive disadvantage to lenders unrestricted by a similar order. As such, as soon as the opportunity arose, Toyota appealed the rate cap requirement.

In some cases, internal changes can influence decisions in a domino effect. Veros Credit LLC increased the volume of information distributed to employees about company policies. That decision, however, led to the realization that the company needed more time to train new hires, Chief Legal Officer Robert Tennant told AFN.

“With the increase in materials, we had to make a decision: How do we teach all of this?” Tennant said. “Do we teach it all in the first week? And that’s when we had to sit down with the board and say, ‘Look, we have a lot more information that we want our team to be aware of, but it’s going to require some buy-in from management because I’m going to need these new hires to train longer.’”

Ultimately, collector training time was increased, but the decision came at the cost of reduced phone time for collectors.

“We did an analysis: If you took training from three to seven days, yes, there’s going to be some loss in income immediately,” Tennant said. “But long term, it’s better to do that and to really establish our policies early on than either having to retrain them later or having some sort of issue crop up that we weren’t expecting.”

The results of the extended training period have been “quantifiable,” Mark Medrano, Veros’s director of compliance and training development, said at the Auto Finance Performance and Compliance Summit.

Timing a New Product

Ally Financial faced a similar situation a few years ago, when it felt that used-car leasing would gain traction in the market. It launched the Ally Pre-Owned SmartLease program in April 2016 with the belief that the used-car market lacked lease providers.

Ally has since scrapped the program, and Vice Chairman of Auto Finance Tim Russi told AFN that the program may have arrived a bit too early. “We put out a used lease program some years ago in anticipation of this way,” Russi said. “Can’t say to date it is something that was a robust choice, but that had a lot to do with where residuals were historically.”

Last month, Ally formed a strategic relationship with Fair, a monthly used leasing startup. In this regard, Ally as found a way back into the used leasing space. “Now, we’re starting to see the gap between a used-vehicle lease and a new-vehicle lease start to ride out to where the used-vehicle lease becomes an attractive price point on less of a commitment,” Russi said.

While some lenders may choose an aggressive approach to opportunity risk, others prefer to let competitors take the plunge first. Consumer Portfolio Services Inc. has been in business for 26 years and rode out three recessions. This is partly due to the lender’s conservative approach to opportunity risk, Michael Lavin, chief legal officer, told AFN. The lender analyzes the available data and will often times let other companies test out the trend, such as offering guaranteed back-end.

“There is a trend in the industry where some of our competitors are doing something called guaranteed back-end when making a loan,” Lavin said. “We have analyzed what a guaranteed back-end is, and how it hamstrings the customer, and how it’s a form of loosening credit, and we have decided not to move forward, [opting instead to] keep our credit criteria tight.”

Opportunity Taking Shape

Opportunity risk considerations are critical to a lender’s decision- making process, said Paul Dacus, chief risk officer at Automobile Acceptance Corp. The Riverdale, Ga.-based company sporadically evaluates new data analytics and origination and collection systems.

“When we are looking at the future of the company, there’s usually a part of the discussion around our systems and what system changes we may consider,” Dacus said. “For example, we periodically look at different origination systems X, Y, and Z. However, we don’t have the resources to implement all three systems. We measure each system’s economic value, and then based on this measurement determine which one of these systems is a better fit for us long term.”

While choices are usually made based on data analysis and market research, sometimes, a course correction is necessary when the market plays out differently than expected. “Many of our decisions are made based on a view or expectation of what will follow,” Dacus said. “These views or expectations are compared to what does or doesn’t happen because of the decision, and sometimes if the view before the decision deviates significantly from the outcome, we look at adjustments or alternatives.”

Opportunity risk is always evolving, so it’s up to lenders to keep their pulse on the market and be realistic about how new products or technologies are playing out. “We feel that the priority of these risks may warrant adjustments to accommodate the changing business environment,” Dacus said. “It’s challenging to determine what tomorrow may hold, but no matter how challenging predicting the future may be, we feel that it’s important to have transparency on all these risks.”

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