Repos and foreclosures are trending up. How should financial institutions prepare?
- More consumers are defaulting on auto and home loans, leading to a notable increase in repossessions and foreclosures and creating risks for financial institutions.
- Financial institutions must prepare to navigate this challenging consumer debt environment by monitoring borrowing data for warning signs and contacting borrowers in danger of default to go after a workout.
- Institutions should also double-check their accounting around repossession and foreclosures, assess their participations and brush up on relevant compliance rules, leaning on advisory support when useful.
Both repossessions and foreclosures have been rising over the past year. The uptick creates additional risk for lenders, especially community financial institutions that have made issuing auto and home loans a core part of their business model.
Are those institutions prepared to deal with this trend, which, for now, seems likely to continue? From an accounting, customer service and risk management perspective, there are key actions you should be taking today to shore up your processes and ready your team.
Keep reading to learn more.
Rising repossessions and foreclosures create risks for financial institutions
With consumer debt recently rising to a record high of almost $19 trillion, Americans are feeling mounting financial pressure. This is starting to show up in repossession and foreclosure rates, the latter of which are higher than at any point in the last 6 years. Consumers are also increasingly underwater on vehicle loans, many of which reflect inflated COVID-era pricing for even used cars.
For financial institutions, this environment comes with risks. Institutions may face increased risk to their actual loan portfolios, as well as related challenges like incorrectly accounting for repossessions in their books. Consider factors like:
- Portfolio risks: Your institution is at risk of a spike in repossessions or foreclosures on the loans you’ve issued directly to customers or members. However, the bigger risk may fall on institutions that participated in loan pools or indirect lending, especially involving auto loans. In these situations, the borrowers may not be your customers or members and lack a relationship with your institution, resulting in less loyalty to repay their loans than borrowers who bank with you. There is also a risk with the reliance on the lead lender’s collection and reporting practices in a participation situation.
- Liquidity dangers: Are you ready to handle a major jump in defaults from a liquidity perspective? For community financial institutions that lack the resources of their giant national competitors, a notable drop in borrowers meeting their repayment obligations could pose a genuine liquidity risk you should weigh with your risk management team.
- Team inexperience: Foreclosure rates are significantly higher than in previous years, so your team may not be fully prepared to navigate an uptick from a process or compliance perspective. This could materialize as inexperience in collection efforts or workouts — with shortfalls in the latter area leading to foreclosures that could otherwise have been avoided had your team been ready to offer restructured payment terms.
- Incorrect accounting: Many financial institutions make GAAP accounting errors with vehicle repossessions. For example, if your institution takes ownership of a vehicle during the repossession process, you are supposed to immediately write down the value of that vehicle. However, institutions often wait until the vehicle is sold before writing it down, which can lead to delayed recognition of losses and regulatory findings.
So what should you do to address these risks? Here’s where to start.
How should financial institution CFOs adapt to meet the current repossession and foreclosure uptick?
To meet the heightened repossession and foreclosure environment, financial institution CFOs and finance leaders should take action to manage risks, improve processes and maintain compliance. Watch for warning signs and make sure you know what to do if more of your loans start going into default, including from both a process and accounting perspective.
Key action steps include:
1. Double-check your accounting processes
Don’t make avoidable accounting mistakes. Double-check your accounting processes to make sure you are accounting for repossessions and foreclosures correctly.
Under GAAP, you should be basing your accounting of either asset type on fair value minus costs to sell, so work with your team to ensure that you’re doing so and consider bringing in additional advisory support if you need further guidance.
2. Get in touch with your borrowers when you notice warning signs
You have a great deal of information about your borrowers, so watch that data and look for warning signs for both individual borrowers and in broader trends. Do you see signs that your customers or members are taking on more credit card debt, perhaps to cover living expenses?
This is a red flag that they may be at risk of falling behind on loan payments.
If you notice a borrower is headed for trouble, don’t wait for them to default. Instead, be proactive: Approach the borrower to go after a workout or a refinance that will allow them to continue meeting their loan obligations.
Also, make sure your team understands how to take this type of action and why it matters.
3. Keep an eye on your participations
If you’re involved in a group of pooled loans with other financial institutions, carefully assess your risks there. Do your due diligence: Get all the documents and reports you can from the lead lender and make sure you know what your options are if the loans in the participation start to go bad. (If you’re the lead lender, make sure you’re sharing all relevant information with the other participants.)
4. Inform your borrowers about last-ditch options
Beyond workouts or refinancing, make sure your borrowers also know about last-ditch options like a voluntary repossession or a deed in lieu. These are obviously far from ideal, but may be less damaging to a borrower’s credit than a standard default and can also allow your institution to complete an inevitable repossession or a foreclosure more quickly.
5. Brush up on compliance rules
Different states have their own rules around repossessions, foreclosures and collections. Make sure you and your team are aware of and in compliance with the appropriate compliance standards for any states you operate in, and that you have access to resources to stay on top of regulatory changes.
6. Decide how to handle collections
Do you handle collections internally or outsource to a collections agency? There’s no right or wrong answer, but think about yours.
7. Reassess your allowance for credit losses
As delinquencies, repossessions and foreclosures increase, make sure your allowance methodology is keeping pace with changing portfolio risk. Review whether your reserves reflect current performance, emerging loss trends and relevant qualitative factors, including economic conditions, collateral values, borrower behavior, underwriting practices and collection experience. Waiting until a loss is realized or collateral is sold can delay recognition of credit deterioration and leave reserves short of the portfolio’s actual risk.
8. Look to advisory support
A third-party advisory and accounting firm can help you better navigate the current consumer debt climate. Look to advisory support to help assess your risks, review your current loan portfolio, double-check your accounting, review your controls and strengthen your regulatory compliance.
How Wipfli can help
We advise financial institutions on risk management, technology, accounting, performance and growth. Let’s talk about the challenges you face today and how we can help you solve them. Start a conversation.
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