Auto Loans

Under the Hood of Subprime Auto: The Timing’s Right for Introspection

Apr 02, 2021 | By JOSEPH CIOFFI

It’s a change of seasons like no other before it. The weather is turning, vaccines are rolling, stimulus is arriving and maybe best of all, Hollywood is luring audiences back to movie theaters to watch titans collide above cities on the biggest screen possible. Down here on the ground, a new administration and an evolving regulatory landscape could bring titanic change to subprime auto. It’s fared relatively well in the pandemic, but now as the light at the end of the tunnel appears, is it a sunny open road ahead or the glaring doom of oncoming headlights? Tell us what you think in our 2021 annual subprime auto survey.

Vindication for the Optimists

From the outset of the pandemic, participants’ steady confidence has been admirable. For those who found the cautious optimism that marked our 2020 studies perplexing, the results to date prove it was warranted. Performance remains steady. Looking at February delinquencies, even the smaller $600 stimulus payments have likely helped keep things in check. KBRA reported early- and late-stage delinquencies in their non-prime auto index were down versus January and year ago levels. Annualized net loss rates have remained relatively flat compared to January and are lower than pre-pandemic levels driven by the strong used vehicle market and low delinquencies.

Of course, we’re not exactly in a rose garden. By the end of 2020, the percentage of borrowers in financial hardship status was 9.8% for subprime customers (double that of near-prime), up from 1% in December 2019.

Fear of the Unknown Remains

In a recent TransUnion report, 38% of U.S. consumers said their household income remains negatively impacted due to the pandemic and 28% of respondents said they would not be able to pay their auto loan (34% for leases). Credit extensions, though below April 2020 levels, have been on the rise. In fact, of those with auto loan accommodations, 20% were hoping to extend the accommodation, and 38% were ready to go back to regular payments but looking to extend the term of the loan. It’s unknown just how much of the trend is seasonal and how much is related to COVID-19.

Regulatory Uncertainty

The general consensus among market players is that there will be more regulation and scrutiny under the new administration. True enough, the CFPB came out of the gate strong in its first case, taking an aggressive position on what type of activities constitute lending and who is subject to its authority. And it was joined by attorneys general of Massachusetts, Virginia and New York in a display of cooperation between the agency and the states, which we expect to see more of going forward.

In the action in the U.S. District Court for the Western District of Virginia, the CFPB claimed jurisdiction over an immigrant bond company, Nexus Services, which, though not a lender, left consumers believing they were providing a financial product or service. There, the CFPB called the use of an English language agreement in a situation where the clients did not speak English to be “abusive.”

Other areas where the market may see greater scrutiny include disparate impact, activities falling under a broader abusiveness standard and generally heightened sensitivity of treatment of consumers in the midst of the pandemic.

Ability to Pay

Although the CFPB requires mortgage lenders to ensure that a borrower has the ability to repay the loan, auto loans do not have such a requirement. But the Massachusetts AG’s pursuit of Credit Acceptance Corporation (CAC) under the Unfair and Deceptive Acts or Practices (UDAP) standard in that state’s consumer protection law has some wondering if that could change. The AG saw CAC’s high interest, high risk subprime auto loans as being made to borrowers that CAC knew or should have known would be unable to repay them.

The complaint alleges that over 50% of the loans extended by CAC end up in default. The complaint alleges that CAC expects, at origination, to only collect on average 70 cents of every dollar. The complaint also alleges that from 2013 to present, CAC does not “consider or determine” the likelihood that a borrower would default when making the loan. As the complaint explains, “[t]he fact that CAC, at origination, does not reasonably believe the borrower will be able to repay the loan is not an oversight; it is a basic feature of CAC’s business model and profit structure.”

This is because CAC’s business model draws profits from the portion of loans that are held back from the dealers and from finance charges, repossession auctions and deficiency collections, so that CAC turns a profit even when many borrowers default.

We’ve heard the concerns of several participants that the ability to pay will get codified into law, but making new law in this area or even a rulemaking by the CFPB would take a great deal of time and political capital. For now, regulators can pursue these issues through the existing enforcement of UDAP as they did with CAC.

Looking Ahead

Preparation is the best antidote for fear and uncertainty. To that end, our currently open 2021 annual subprime auto survey will gauge participants’ expectations for future performance and the impact of regulatory changes. The survey gives market professionals an opportunity to share their views on the enforcement issues that concern them the most and how they intend to adjust behavior. Those who take the survey will also receive a copy of the market study and be able to learn just what lenders, servicers, investors, trustees really think and if outlooks vary by group.

The road to a more predictable future is paved by sharing expectations. Take the survey here.

In addition, I recently sat down with Joel Kennedy for the ConsumerFi Podcast and discussed the state of the market and impact of regulatory changes. You can listen to the full podcast episode here.

Nicole Serratore, an attorney in the Insolvency, Creditors’ Rights + Financial Products Practice Group of Davis+Gilbert, contributed to this post.