Bank of America restarts auto loan business despite warning signs

(This version of the March 3 article corrects paragraph 33 to indicate that Patrick Kaser is a portfolio manager at Brandywine Global Investment Management, not Brandywine Asset Management)

The Bank of America building is shown in Los Angeles, California October 29, 2014. REUTERS/Mike Blake

(Reuters) – Bank of America BAC.N is making a big move toward auto lending just as regulators are sending warning signals, auto loan losses are mounting and rivals are getting more cautious after years of strong returns.

The bank tapped mortgage executives Matt Vernon and John Schleck to lead the auto loan business last May, saying they would be able to sell auto loans alongside other products such as checking accounts and credit cards. home equity loans.

In interviews, executives and their boss, D. Steve Boland, who oversees a wide range of consumer loans, said they still see room for growth in borrowers with good credit. They’ve been hiring heavily in recent months, adding dozens of loan officers and salespeople.

But some competitors and banking analysts said hiring didn’t make sense at this point because auto sales could be on the verge of peaking and consumer credit shows signs of weakness.

Across the sector, banks classified $1.1 billion in auto loans as bad in the fourth quarter, according to the Federal Deposit Insurance Corp. This represents an increase of 15% over the previous year and 39% since the fourth quarter of 2011. Ultimately, a large part of these bad debts turn into losses for the banks.

For a graph showing auto loans in arrears of 30 to 89 days and a projection of auto sales, see tmsnrt.rs/24xv9vV

“I’m not actively hiring or growing our operations on the platform. That’s for sure,” said Andrew Stuart, head of TD Auto Finance, which is slightly smaller than Bank of America’s auto business.

At a conference on February 10, Capital One Financial Corp. COF.N CEO Richard Fairbank said while auto loans provided “once in a lifetime returns” after the financial crisis, the business began to falter. In a January interview on CNBC, JPMorgan CEO Jamie Dimon called the market “tight”.

Portales Partners analyst Charles Peabody said Bank of America is late to the auto loan party. But in his defense, he noted that the bank’s chief executive, Brian Moynihan, and his management team were too busy trying to solve problems with mortgages when the auto loan business seemed like a smarter bet. .

“They should have reinforced this thing two years ago, but two years ago Moynihan was still trying to stabilize the ship,” Peabody said.

SLOWING THE MOMENTUM

All banks are struggling to raise revenue during a period of stubbornly low interest rates and tight post-crisis regulation, but Bank of America has felt the pain more intensely than most of its peers.

The second-largest US bank by assets, Bank of America trades at just 50% of its book value, compared to 90% for JP Morgan Chase & Co. JPM.N and 130% for Wells Fargo & Co WFC.N. Bank of America suffered bigger losses than its rivals during the crisis, and continues to lag other key metrics including return on equity and costs relative to revenue.

While Bank of America showed some progress in 2015, it has yet to prove it can generate consistent performance under Moynihan, who took the helm in 2010. During his tenure, the bank paid tens of billions of dollars in mortgage fines and settlements. issued before he became CEO.

Bank of America ranks 10th among U.S. auto lenders, with just 1.84% of the market in the fourth quarter of last year, according to data released Thursday by Experian Automotive. Ally Financial Inc. ALLY.N, the largest US auto lender, accounts for 5.75%, followed by Wells Fargo, which ranked second with 5.66%. JPMorgan was third with 4.97%.

Automobile sales remain very robust. Figures released by automakers on Tuesday showed sales hit a 15-year high for the month of February, driven by low gas prices, rising wages and because loans are both available and cheap. But most forecasters expect sales to peak in 2016 and decline over the next few years.

“We remain in the ‘plateau’ camp,” RBC Capital Markets analyst Joseph Spak wrote on Tuesday, sticking to his stable sales forecast.

Stocks have fallen significantly in recent months on worries about the global economy, and some companies that make money selling or financing vehicles have been hit even harder. They recouped some of those losses after the latest sales figures.

Ford Motor Co. FN and General Motors Co. GM.N are down around 6 and 11%, respectively, since the start of the year, while publicly traded auto lenders Santander Consumer SC.N and Ally are down 35.7% and 2.8%, respectively. The S&P 500 Index .SPX has fallen 2.8% so far this year.

Delinquencies on bonds made up of subprime auto loans hit their highest level in six years, Fitch Ratings said last week. According to the FDIC, 1.82% of all auto loans were 30 to 89 days past due during the fourth quarter — the highest rate on record since the FDIC began tracking in 2011.

As weakness in the automotive sector became evident, regulators began to sound the alarm.

In an October speech, U.S. Comptroller of the Currency Thomas Curry warned of the risks associated with subprime auto loans, as well as loans that mature in six years or more, which tend to be given to customers who cannot afford monthly payments on loans with shorter terms. In November, the Federal Reserve Bank of New York released a report on auto loans that showed a growing share of loans going to consumers with poor credit.

FOCUSED ON PREMIUM

Bank of America says it focuses strictly on prime and “superprime” customers. The “by far majority” of its auto borrowers have credit scores above 700, Vernon said. Borrowers with credit scores above 660 are generally considered to have good credit.

Still, a decline in used car values ​​would reduce recoveries on loans that go bad, and the longer the loan term, the greater the exposure to such risk. Bank of America will lend for up to 75 months – slightly longer than the six years that Comptroller Curry cited as a concern – although Vernon said the average term is much lower.

The bank doesn’t release granular data on its auto loan portfolio, so it’s unclear how the credit quality of its borrowers has held up over time. In data provided to Reuters, Bank of America said it issued $23.7 billion in auto and leisure vehicle loans in 2015, up 41% from 2014.

Most of that growth came from auto dealerships, the region Vernon oversees, and much of it happened in the fourth quarter after hiring seven “relationship managers” whose job it is to develop business with dealerships in across the country. Vernon is targeting 5-10% growth for its operation in 2016.

Schleck, who oversees the firm that works directly with retail customers, also slashed staff – nearly doubling the number of loan officers to 110 from 60 since last May. Although Schleck said it is unlikely to continue to increase its staff at this rate, it could hire more this year if demand warrants. Similarly, if demand cools, Schleck said he is ready to cut staff.

“I needed to get to a certain level to be able to provide a certain level of service and I needed to get there very quickly – and I did,” he said. “Before May there were probably a lot of lost opportunities, whereas after May I capture what we might have been able to capture earlier.”

Boland, their boss, said it’s true that Bank of America was “in a different place in 2012,” but disputed the idea that the bank is too late to expand its auto lending business.

“I don’t feel like I’m late at all,” he said. “There is no timing problem. I will continue to focus on growing our consumer loans. »

As long as the bank is cautious of borrowers and keeps staff in line with demand, it can grow simply by selling to more of its existing customers, Boland added.

Patrick Kaser, portfolio manager at Brandywine Global Investment Management, which owns about 26 million shares of Bank of America, said the bank’s strategy is sound even if it comes at a less than optimal time. The bank pulled “far too much” from some businesses after the shock of its mortgage losses and fines, and re-entering the market with a focus on healthy consumers makes sense, he said.

“Only time will tell if they come in at the top and whether or not they’ll be too aggressive,” Kaser said, “but banks have a lot of incentives to be disciplined.”

Reporting by Dan Freed; Editing by Lauren Tara LaCapra and Martin Howell