Understanding the impact on household credit
by James Frischling, President, and by Ron D’Vari, CEO, New Oak NewOak is an independent financial services advisory firm built for today’s global markets. Led by a team of experienced market and legal practitioners, NewOak provides a broad range of services across multiple asset classes, complex securities and structured products for banks, insurers, asset managers, law firms and regulators, including financial advisory and dispute resolution, valuation, credit and compliance, risk management, stress testing, model validation and financial technology solutions. We have analyzed or advised on more than $4.5 trillion in assets to date. Visit newoak.com
The mortgage crisis and the regulatory response it spawned receive well deserved attention. The importance of housing to the U.S. economy can’t be understated, and the availability of credit to support the housing market is a key driver.
A distant second in household credit (but still in excess of $1 trillion dollars) is student loan debt. The rising cost of college, the readiness of students for jobs, the creation of an indebted generation and its impact on the U.S. economy also receives well-deserved attention.
However, the asset class that takes the bronze medal in the household credit market is auto loans, a market where over 80% of new car purchases involve borrowers that secure financing. This market is no longer flying under the radar, and the Consumer Financial Protection Bureau (CFPB) has clearly taken notice. Much has been written about banks tightening their credit standards and defenders of the banks point to the CFPB, Dodd-Frank and the Securities and Exchange Commission (as well as the mountain of litigation the banks continue to face as a result of suspect lending practices) as the reasons they have changed operating procedures as it pertains to consumer lending.
However, while banks and credit unions are regulated entities, much of auto loan or car leasing operations are executed through non-bank channels that are far less regulated. Financing arms of the auto manufacturers as well as other non-bank finance companies are responsible for nearly 50% of outstanding auto loans. So what happens when credit is made easily available?
The number of leased versus purchased cars has doubled over the past five years. The CFPB has identified the mounting risk in the auto loan market and is trying to have non-bank finance companies brought under their supervision. Are they overreaching or have they identified a systemic risk to the economy? Short answer, bronze medal winners deserve attention too.
Operational Risk Measurement: Investment Banking Draws Attention
Operational risk may be defined as the risk of loss resulting from inadequate or failed internal processes, people, systems or external events. This definition includes legal risk but excludes strategic and reputational risks that may be affected should that legal risk lead to a public dispute or litigation. One key area that has been getting increasing attention from regulators is management’s ability to fully understand its investment banking operational and litigation risks. Investment banks engage in advising on mergers and acquisitions (M&A), recapitalizations, going-private transactions, debt and equity capital market transactions or act as principal in M&A and/or financing. These types of activities often lead to litigation that can be costly and distracting to management. The issues may involve lack of adequate disclosure, misrepresentation, inadequate or inaccurate accounting, inaccurate fundamental valuation of equity or debt, credit and solvency, shareholder actions, fraudulent transfer, etc. Identifying and quantifying these risks in potential litigations require forensic analysis and deep knowledge of the relevant business lines. There have been many incidents in which losses related to operational risk, particularly legal matters, have led to the weakening of otherwise healthy financial institutions. Operational risk issues at investment banks are not only becoming more costly to address, but the reputational repercussions also can affect stock prices. As a result, bank regulators are demanding a much greater level of monitoring and awareness by management and the board of directors around the operational risks specific to investment banking. Gradually, the banks are recognizing that effective processes and controls to identify, monitor, manage and mitigate operational risks play a key role in the profitability and long-term growth of their institutions. Regulators have made it abundantly clear that they want to see a direct connection between capital allocation and the specific ways a bank measures and manages its specific operational risks. The regulators’ intent is to better align regulatory capital with banks’ inherent risks and economic capital. Given the complex nature of investment banking activities, the associated operational risk modeling techniques and frameworks are expected start out simple and become more comprehensive over time.