The financial services industry is continuously evolving, and it is essential to optimize collections strategies to maintain liquidity and minimize risk. One of the most critical choices for credit un...
Lending
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As we discussed in part one of our Q1-2 2023 Economic Outlook, the financial sector appears well-positioned for an economic downturn.
That being said, we are seeing the deterioration in delinquencies we have been forecasting.
Both banks and credit unions are seeing an uptick in delinquencies on 1-4 family mortgages and consumer loans (credit cards and autos). Banks are also seeing some deterioration in commercial real estate delinquencies.
While these levels are still nowhere near their pre-pandemic levels, it is clear consumers are struggling to keep up and we expect this to continue as long as inflation outpaces wage gains.
Auto Lending Outlook
An area of particular concern for us is auto lending, especially for used vehicles. Deterioration in credit union auto loan portfolios has begun.
Anecdotally, we are hearing from a number of credit unions of a very noticeable uptick in bankruptcies and defaults, particularly on autos, in the first two months of 2023.
While not yet in the data, we expect this trend to continue as borrowers are carrying tremendous amounts of negative equity on many used cars purchased over the past couple of years.
Despite a surprising recent resurgence in used car prices, we do expect values to migrate back to historical norms as new car production normalizes. Lenders will have to watch LTV ratios for new loans carefully in a falling used vehicle market. Additionally, they will need to be prepared for the inevitable uptick in delinquencies and defaults/charge-offs.
We have also noticed a significant uptick in insurance coverage lapses on autos. This is often a precursor to deterioration in delinquencies and further reflection of the stress consumers are under.
The good news is, the financial industry seems well-braced for this impending deterioration in loan performance. Both banks and credit unions have increased their loan loss reserves over the past year, and the industry’s reserve coverage ratio is the highest on record.
Recommendations for Financial Institutions
The number one priority for financial institutions should be to manage interest rate risk on their balance sheets caused by the rapid rate increase environment. Similarly, understand concentration risks in investments, lending, and deposits and how they may be impacted by the higher rate environment.
Financial institutions should continue monitoring and managing underperforming assets, be prudent with lending activities (LTV ratios), and expect loan demand to be challenged as 2023 unfurls.
Lenders should also make sure collections efforts are prepared for the pick-up in activity they’re likely to see. Be sure insurance monitoring is in place on assets (homes, autos, and commercial real estate) on which loans are drawn.
The challenging environment will be a good opportunity to gain market share from weaker competitors either through organic or acquisition-driven growth.
Additionally, there will be an opportunity to obtain talent later in the year as unemployment ticks up and less well-positioned financial institutions shed employees. Take advantage of these opportunities early. The downturn will not be long in duration or deep in the overall impact on the economy and jobs.
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