Black Book vice president of data licensing Jared Kalfus described the industry “crossroads” finance company executives are assessing based on his first-hand conversations at last month’s Used Car Week in Las Vegas.

What has finance company leadership pondering which way to turn at this “crossroads?” Analysts from firms such as Black Book and TransUnion are finding that loan-to-value ratios are strong indicators for severity of loss. They say the lower a vehicle’s equity position, the lower the loan recovery rate and the higher the severity of loss.

“If we look back historically, lenders have used more traditional risk measurements, including credit score, time to maturity and the size of the loan. And when you observe these loans on paper just by looking at them, many look the same until the vehicle equity position is truly factored in and considered,” Kalfus told SubPrime Auto Finance News during a recent phone interview.

“When you start to consider the equity position that vehicle might have, that’s when you really start to underscore the fact that vehicle values are a critical component when evaluating these individual loans and portfolios,” he continued.

In analyzing more than 800,000 loans, a recent study with TransUnion showed that there is a strong correlation between LTV ratios and frequency of loss.

As an example, in looking at two loans that each had a balance of $7,500, a customer credit score of 720, and 24 months to maturity, one vehicle was valued at $12,500, and a second was valued at $4,500. The study showed that the latter loan will, in fact, default more frequently.

Black Book vice president of analytics Anil Goyal indicated the study results showed that finance companies that tracked LTVs closely enjoyed a “significant lift in predicative power by using equity in the whole process.

“That can give an edge to lenders. More accurate prediction of delinquency and default can help in better loss forecasting, better prioritization of collection activities and better forecasting of repayment rates,” Goyal continued.

Goyal added that watching LTVs is especially important as Black Book anticipates the decline of its vehicle value index after 36 months of record high levels.

“This is really important from a lending perspective because the vehicle value trends are all evolving,” Goyal said. “Early in the year in the spring, we saw the compact car segment for example was very strong, and now that segment is under pressure.

“On the other hand, now we’re seeing full-size SUVs and pickups are retaining their values here late in the year when usually we see a steeper depreciation,” he continued.

“The takeaway for the lenders is really to have a balanced portfolio and monitor the collateral values with accurate data and use that in their predicative models on a regular basis so they can have an edge,” Goyal went on to say.

That edge is part of why Kalfus mentioned that he saw the “crossroads” appear again during Used Car Week. Kalfus shared that he was having a conversation with a finance company executive who was quite familiar with the recent analysis by Black Book and TransUnion and recently implemented the LTV metric into its ongoing portfolio analysis. An executive from a different finance company overhead the discussion and joined in because he wanted to know more about to integrate LTV data into risk mitigation.

Kalfus acknowledged the finance company executive familiar with the data basically took over the pitch the Black Book VP typically makes, creating a “pleasant surprise.”

Kalfus continued, “The more data that finance companies use, the more predicative they will be, the more on top of their portfolios they will be. They can work to mitigate their risk.

“Our takeaway to reinforce the message in the conversation we’ve been having with lenders in the automotive finance community is that collateral values have a critical role in the overall underwriting, risk mitigation, and ultimately, long-term portfolio management,” he went on to say. “If they start to incorporate these traits and characteristics into their every-day portfolio management, then they’ll not only have more profitable portfolio, they’ll reduce their risk.”

And Goyal pointed out that finance companies can integrate LTV analysis into their portfolio management strategy in the same way they might watch credit scores.

“They’re all using similar techniques in terms of regression analysis to factor in whatever data they can get, whether it’s from the credit bureau or alternative data providers. Using equity in the whole mix can give you an edge,” Goyal said.

“When I talked to lenders, they are anticipating an uptick in delinquency, and that doesn’t scare them because the delinquency levels are pretty low,” he continued. “What they are concerned about is the vehicle valuations, where they’re going to be next year. What we’re seeing is there’s a lot more volatility across the different segments. They’re not all moving the same way. Some segments are dropping faster; some are not.

“That factor is what going to be important in assessing where your portfolio is moving,” Goyal went on to say. “Is your portfolio continuing to be balanced? Are you tracking your portfolio to determine where your risks are and using that data to prioritize where you want to work?”

Perhaps that’s why Kalfus indicated the industry is at a “crossroads.”

Kalfus closed his comments to SubPrime Auto Finance News by emphasizing, “Lenders are really more engaged.”