by Tim Condon (www.leapautoloans.com)
The last few years have been a
watershed time in our economy and industry. Past recessions have mostly followed a regular
pattern of unemployment and inventory reductions, and were followed by strong
recoveries as inventories adjusted and job growth ensued. It is pretty clear that this past recession
and recovery were different in important ways, and many of the problems we are
facing are structural and long term. As
it relates to auto lending, there are some specific changes in the economy and
consumer behavior that should be considered in the way lenders manage auto loan
portfolios.
Credit priorities for consumers have changed. The ongoing wave of mortgage defaults have
taught borrowers to think more strategically about how they pay debt and obtain
credit. In the past, consumers were
embarrassed to admit falling behind on a mortgage. Today, strategic defaults are openly
discussed and even encouraged in some circles.
Conversely, consumers pay their cell phone and cable bills with alacrity
so they won’t be left “off the grid.”
Credit cards were useful in the past not just as a way of managing
personal liquidity, but also as a convenient transaction tool. Debit cards have now become pervasive, so
strapped consumers are less worried about the need to obtain a credit card for
things like travel and online purchases.
In the auto lending arena, most
American communities are set up in a way that people need to drive to work or
around town. There is no
alternative. Although people need cars,
there are a variety of ways to obtain them, and families often have two or more
cars even if they have credit challenges.
Purchasing a car can often be deferred.
As a result, payment of auto debt
often represents a strategic decision for consumers who are facing tradeoffs.
Consumer budgets are being squeezed. The most widely reported measure of the
economic downturn was the unemployment rate.
There are roughly 14 million workers officially unemployed, about 8
million more than a few years ago. Add
to that another 8 million of part-time or underemployed workers. Disposable household incomes in the middle
tiers are sharply lower than a few years ago, and the pressure is compounded as
use of home equity to make ends meet is no longer an option. We hear stories every day underlining the
reduced disposable income of the average consumer. Walmart executives provided a telling example
in their most recent earnings call: More
Americans are buying half-gallon containers of milk because they cannot afford
a full gallon.
Despite this backdrop of economic
malaise, the auto lending sector looks strong, with defaults near record lows,
good margins on new originations, and growing profits as car sales expand. Credit tightening and a shift in consumer
credit priorities have proved beneficial for auto lenders. With such solid portfolio performance and
plenty of available capital, most lenders are not facing a need to make radical
changes.
Nonetheless, there are many
consumers struggling with auto debt.
Repossession activity has declined sharply over the last two years due
to tightened underwriting and car sales in 2008 and 2009, but repossessions
will still likely exceed 1.3 million units in 2011. In many cases, repossession is the best solution
for the lender, but there is still a great opportunity to lower the number of
repossessions, save money and keep people in their cards. It is apparent that the jobless rate will
remain high for an extended period, which will require lenders to find
out-of-the-box solutions to managing their auto loan delinquencies.
At LEAP, we deal with customers
facing repossession every day, all day long.
In a changed economy, we believe lenders should carefully reconsider
their workout programs to better fit consumer needs. Here are some repossession myths that should
be challenged:
Myth 1: "The
customer can’t afford the car, so the best course of action is to repossess and
sell it.”
Typical customers in repossession
represent normal, middle income folks. Based
on our data, average annual income is about $36,000 to $40,000 per year. For large lenders who finance new vehicles
the average income is even higher, in the $40,000 to $50,000 range. About a third of the customers own homes. So
why didn’t they pay their auto loan?
Usually there has been either a temporary disruption in the ability to
pay (e.g. unemployment followed by a new job), or a significant reduction in
total household income (e.g. spouse lost a job). The customer still has the ability to keep
making payments, but cannot afford to catch up on past payments or continue
making large payments. Sometimes a
payment adjustment is all that is needed to get them back on track.
Myth 2: "The
customer has no alternatives.”
A delinquency is usually not a
surprise event for the customer. They
have likely thought about alternatives to their current vehicle, and may already
have one arranged. Often we speak with people facing repossession who feel they
have not been treated fairly in the dealership or by the lender. Their car is worth far less than they owe on
the loan, and it is getting expensive to repair mechanical problems. If the lender will not work with the customer
and the payment is too high, then they often seek other transportation
solutions. Once they find a better alternative, the lender gets a voluntary
repossession. “You want this stinky old heap?
Come and get it.” Lenders would
be remiss to disregard these customers and think they have no options.
Myth 3: "If a
lender begins settling with customers or reducing payments, it will just
encourage others to ask for a payment reduction.”
Repossession is a humiliating and
emotional experience for the vast majority of people. We have not found anyone who went through the
process as a way of getting a payment reduction.
Myth 4: "If a
customer is delinquent, a lender should always ask for total amount due.”
Delinquency should be treated as a
red flag. Reasons for delinquency should
be closely tracked. Even if a collector
can coax a customer to send the total amount due, there may be underlying
reasons for the delinquency that will persist, and eventually cause
repossession. It is better to understand
the issues early so that the loan can be restructured to fit the circumstances.
Myth 5: "All
people with a prior repossession represent high risk”.
Many consumers are coming out of
the recession with damaged credit due to unemployment or underemployment. Although their bureau scores might be low,
there are many who behave in a “prime” fashion.
They are knowledgeable about financial products, communicate well, take
responsibility and pay on time. It is
sometimes difficult to segment risk in this population with traditional bureau
data, but there are good risks nonetheless.
Myth 6: "All
“skips” are very high risks and should never be reinstated.”
In many areas of the country it is
impossible to live without a car. People
cannot realistically get to work, the grocery store or meet daily needs. When the car is out for repossession,
customers sometimes panic and hide the car or switch with someone else until
they can figure out a way to get back on track.
The notion that the consumer has ‘skipped town’ just isn’t true these
days. The customer obviously wants the
vehicle, and if they have a compelling reason to step forward with a deal they
can afford, they often will. LEAP has
very good results with former “skips”.
We lower their payments, and give them a compelling reason to step
forward. Subsequent performance has been great.
Myth 7: "The
lender should limit settlements to a percentage of outstanding loan balance.”
Most lenders have policies that
limit the amount of principal write down that can occur with a restructuring or
settlement. Instead, lenders should
consider the alternative. Repossessing
and selling the car at auction is an expensive solution that almost always
results in a large loss for the lender.
If the customer is willing to pay you more than you can get at auction
because it is worth more to them, you should strongly consider taking it. The loan balance is a sunk cost. If you can find a way to keep the customer in
the vehicle, you have a much better chance of collecting more money. Chasing deficiency balances is generally
unproductive and expensive. Be
realistic.
Summary
A typical sequence in repossession
is that the customer loses his vehicle and damages his credit, and the lender
loses significant money. Auctions make a
substantial profit, dealers buy the vehicles at wholesale, and the customer
gets a different vehicle at a substantial markup.
When it comes to repossession, we
say ‘don’t judge a book by its cover’. Lenders
can sometimes do better, and we believe they have a moral obligation to
try. The customer is under stress, but
they most often will make decisions in their rational self- interests, the same
as any other consumer. By changing the
tone of the conversation with delinquent customers, accepting that past costs
are sunk, and offering the customer a benefit in resuming reasonable payments,
lenders will reduce losses and more customers will keep their cars.