estimating auto lending fraud losses€¦ · introduction – auto lending fraud risk is rising...

Auto Lending Fraud Losses in 2017

Visit us at www.pointpredictive.com

WHITEPAPER

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ABOUT POINTPREDICTIVE PointPredictive Inc. is a leading provider of fraud solutions to banks, lenders and finance companies. It solves the billion-dollar fraud problems of auto lending, mortgage lending and on-line retail fraud with the latest technology platforms, smarter science and business experience by leveraging big data with analytic models. The PointPredictive Auto Fraud Manager solution helps banks, lenders and finance companies solve the problem of fraud, early payment default and dealer risk for automotive lending. Leveraging a collaborative fraud consortium, the pattern recognition models can precisely identify risk and reduce both Fraud and Early Payment Default Losses by 50% or more with low false positive rates. Located in San Diego, Calif., more information about PointPredictive can be found at www.pointpredictive.com

Estimating Auto Lending Fraud Losses for 2017

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INTRODUCTION – AUTO LENDING FRAUD RISK IS RISING Auto lenders in the US are experiencing increased losses due to fraud and early/first payment default as they struggle to maintain loan quality amid rising auto loan origination volumes. In the last quarter of 2016, uncollectible auto loans soared to over $1.1 Billion dollars and delinquencies on subprime loans hit their highest level since the worst recession in US history. With auto lending levels soaring to historical highs and delinquency losses rising dramatically, many lenders have a heightened sensitivity to fraud and its impact on their bottom line. Traditional fraud and risk management processes are also challenged by the changing portfolio risk profile as almost 20% of all new auto loans are issued to non-prime borrowers, according to recent Experian data.

Similarities to the Mortgage Industry

It is not unlike what the mortgage industry experienced between 2003 and 2008. In 2003, mortgage lending volumes were hitting record levels due to an increase in indirect lending through brokers as well as an increase in non-prime lending. By 2008, the mortgage industry was melting down – in large part due to rampant fraud that was hidden in these broker and non-prime applications and then misclassified as credit loss.

Fast-forward 8 years and the US auto industry is experiencing the same types of rapid growth, which is fueling the same sparks of fraud risk that erupted in the mortgage industry.

To understand the impact of rising fraud, PointPredictive leveraged predictive algorithms and application analysis by fraud experts to estimate auto lending fraud risk for 2017.

Based on that analysis, PointPredictive now estimates the level of annual fraud risk to be between $4 Billion and $6 Billion.

This is double the annual amount that we estimated just one to two years ago. This whitepaper explores the components of that

fraud risk and the drivers that are contributing to the rising level of auto lending losses in the industry.


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AUTO LENDING FRAUD MAY BE KNOWN OR HIDDEN There is no central reporting agency for collecting and reporting on auto lending fraud losses in the US. This makes assessing the absolute levels of fraud losses in the US very challenging. Even if there was a centralized reporting structure for confirmed frauds, it would tend to understate the impact of fraud since our research indicates that a substantial portion of application fraud is misclassified as a credit loss.

Because of this, the best approach to this problem is to review past applications, leveraging statistical models and industry experts to form a complete picture of fraud. By applying those findings to current lending estimates, we can arrive at the annual levels of loss on based on new applications, originated loans and expected default rates on those loans. This is the approach used by PointPredictive to estimate annual levels of fraud originations in the US each year.

Known Fraud and Unknown Hidden Fraud

The cost of auto lending fraud does hit the bottom line of banks and lenders but it may not always be categorized or recognized as a fraud loss. In the case of auto lending fraud, there is both Known Fraud and Unknown Fraud.

Known Fraud - Some fraud is identified either before an auto loan is originated or shortly afterwards when a borrower notifies the lender of identity theft or a lender discovers the fraud in their collections process

Known fraud is more common than you might expect and is present on approximately 0.30% (30 basis points) of originated application volume.

Unknown Fraud - Some fraud is never identified – not during the application process and not even after a loan has been funded and defaults. This fraud, in most cases, results in early or first payment default where the borrower never makes a payment on their loan after they walk out of the dealership.

Data and investigative analysis of early payment default loans indicate that between 40% and 70% of those loans have significant misrepresentation on the original loan application which led to the financial loss.

You Can’t Fight Auto Fraud With Credit Risk Tools


Known auto lending fraud can run approximately 0.30% (30 basis points) of origination volume at lenders.

Unknown auto lending fraud typically manifest as early payment default, which can run as high as 3% of originations.

40% to 70% of early payment defaults have been linked to fraud when the original application is examined.

KEY FINDINGS

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5 Estimating Auto Lending Fraud Losses for 2017

AUTO LENDING FRAUD TYPES CATEGORIES

Based on analysis of application data and loan servicing data by industry fraud experts, PointPredictive breaks down fraud losses in three distinct categories:

Early Payment Default Fraud – Loans that default within the first 6 months have a much higher probability of containing material misrepresentations in the original loan application than loans that default later. PointPredictive analysis suggests that 40% to 70% of early payment defaults have some element of misrepresentation in the initial application that led to the loss. The range depends on the lender’s pre-application fraud controls as well as the underlying risk of the loan program itself.

Dealer Fraud – Auto lenders, particularly those concentrating in non-prime lending, experience high levels of losses that can be tied back to specific dealers. Some dealers have extremely high levels of early payment default, known fraud and bad loan quality that leads to losses. These losses may not always be categorized as fraud. However, through careful retrospective analysis, lenders often determine that many of the losses they take are due to intentional misrepresentation are clearly the result of a systemic, organized attacks originating from within the dealers’ finance organizations.

PointPredictive analysis has determined that, for some lenders, virtually 100% of their fraud losses are associated with fewer than 3% of their dealers and nearly 100% of their early payment default losses come from just 10% of their dealers.

Known Fraud and Misrepresentation – Most auto lenders do have some tracking systems in place for fraud losses; however, that rarely provides a complete picture of their losses since so much fraud is hidden. Identity Theft, Straw Borrower, Collateral and Dealer Fraud are generally the most common categories of fraud losses that lenders experience. Known fraud and misrepresentation levels can vary from lender to lender based on their pre- and post-funding fraud controls as well as the level of reporting that they do concerning fraud. On average, PointPredictive finds that a lender’s known fraud is approximately 0.30% (30 basis points) of originated volume.

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AUTO LENDING FRAUD WILL REACH $4 TO $6 BILLION IN 2017 After analyzing both known and unknown fraud, PointPredictive estimates that there will be $4 to $6 billion in fraud for loans originated in 2017. This estimate was based on origination volume of new and used car auto loans of approximately $600 billion and the estimated rate fraud for both known and unknown fraud types.

PointPredictive Low Estimate - $4 Billion in Fraud for 2017 PointPredictive’s low estimate for 2017 is $4 billion in originations with fraud that will lead to a financial loss. This assumes an average industry early payment default rate of 1% (some lenders are lower, some are higher) and assumes our low range estimate of early payment defaults that are linked to fraud of 40%. PointPredictive High Estimate - $6 Billion in Fraud for 2017 PointPredictive’s high estimate for 2017 is $6 billion in originations with fraud that will lead to a financial loss. This assumes an average industry early payment default rate of 1% (some lenders are lower, some are higher) and assumes our low range estimate of early payment defaults that are linked to fraud of 70%.

Low Estimate High Estimate

Unknown Fraud (Early Payment Default) 0.40% 0.70%

Known Fraud (Misrepresentation) 0.30% 0.30%

Total Originated Fraud $4.2 Billion $6 Billion

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FRAUD IS INCREASING DUE TO MANY FACTORS Auto lenders are increasingly taking proactive measures to identify and reduce their fraud exposure. This is particularly true for non-prime lenders who have noticed sharp increases in fraud from dealers that are trying to push more risky loans and putting fabricated documentation such as fake paycheck stubs in loan files to perpetrate fraud schemes. PointPredictive believes that fraud levels are rising based on several market factors:

1) An increase in overall lending volumes and auto sales over the last year. 2) An increase in lending volumes to higher risk, non-prime borrowers. 3) An increase in fraud misrepresentations linked to early payment default as some

dealers try to push bad loans to lenders. The combination of these factors has driven PointPredictive to increase the estimate of annual fraud from $2 to $3 billion for 2015 to $4 to $6 billion for 2017. Originations Volumes Projected to Remain Flat But Risky Lending Could Increase Origination volumes are projected to remain flat for 2017, however increased competition in the auto sales and lending market could continue to drive riskier lending. Riskier lending programs in almost all cases result in higher rates of fraud. PointPredictive believes both known and unknown fraud rates could increase as the absolute level of misrepresentation increases in the loan file. Rising Interest Rates, Car Prices and Deregulation Rising interest rates and threatened import tariffs will make cars more expensive and potentially drive more borrowers and dealers to misrepresent information on the applications to get loans approved and funded. Rising interest rates are often linked to higher rates of fraud across industries. Tightening credit risk policies will only cause the borrowers and dealers to become more creative in misrepresenting the information. Additionally, banking experts are projecting a favorable environment for deregulation as the new administration seeks to remove requirements that have constrained bank lending. Periods of deregulation often drive higher lending but are also marked by higher levels of fraud as banks and lenders move to progressively more risky lending to capture more market share.

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You Can’t Fight Auto Fraud With Credit Risk Tools

HOW POINTPREDICTIVE HELPS AUTO LENDERS PointPredictive provides both fraud solutions and consulting packages to help auto lenders assess and control their potential losses due to fraud, early payment default and dealer risk. Scoring Solutions For Fraud, Dealer and Early Payment Default PointPredictive provides the auto lending industry the only consortium-based pattern recognition system that can identify all fraud issues on applications and existing loan portfolios. The solution is built on the fraud patterns contained in millions of historical applications and provides a risk score from 1 (low risk) to 999 (high risk) for each component of risk: misrepresentation, dealer risk and early payment default risk. Each score is accompanied by up to three reason codes to help the lender understand the particular type of risk presented by the score and what actions might be useful to mitigate that risk.

Fraud Consulting and Strategy In addition to fraud solutions, PointPredictive provides fraud consulting and advisory services to assist auto lenders in building their fraud prevention programs. PointPredictive has provided fraud advisory services for more than 150 financial institutions to help them reduce their risk exposure. Fraud Consortium and Collaboration PointPredictive hosts the auto lending industry’s first auto lending fraud consortium. The fraud consortium enables lenders to share their patterns of fraud and default to reduce fraud across the entire industry. By participating in the consortium, the lender is able to significantly reduce their losses due to fraud, early payment default and dealer fraud.

Analytic scoring models offer unique insight into fraud risk by looking at the patterns of fraud, early pay default and dealer risk across millions of loans. Scores analyze complete risk to reduce defaults and losses. Scoring solutions can be run retrospectively on loan portfolios, in batch on applications as they are submitted or in real time to instantly identify the risk of each application and dealer for every transaction.


estimating auto lending fraud losses€¦ · introduction – auto lending fraud risk is rising...

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