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. e. Purchasing a car a 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:
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.
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.
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.
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.
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.
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’ often 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.
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.
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.