How subprime lenders face the coronavirus economy

What a difference a few months make. Last year, subprime lenders outpaced banks, captives and credit unions at a rate of eight to one in origination growth. Among the 10 largest independent subprime lenders, originations shot up an average of 43.9%, compared with a 5.5% growth rate among other lender types, according to the 2020 Big Wheels Auto Finance Data Report . With a stable lending backdrop, financiers of all sizes had been enhancing their technology and tools to increase loan volume. Carvana and Exeter Finance doubled originations last year, while Global Lending Services (GLS) , American Credit Acceptance Corp. , Flagship Credit Acceptance and Westlake Financial Services recorded origination growth in the 40%-60% range. Yet, the pendulum of originations has quickly swung in the opposite direction. Finance companies that cater to consumers with tarnished credit histories have tightened lending guidelines in preparation for fallout from COVID-19. Underwriting and pricing adjustments to lower target-loss expectations and increase minimum income requirements contributed to a 75% drop in originations at Global Lending Services in March and April. Meanwhile tighter underwriting has contributed to a 43% year-over-year drop in originations at Westlake, according to assessments by Kroll Bond Rating Agency . At Credit Acceptance Corp. , which reported first-quarter earnings this week, origination volume by unit declined 22.3% YoY in March and again in April. Beyond declining originations, subprime lenders face challenges related to staffing and remarketing. Exeter laid off 29 employees last month, according to a notice filed with the Texas Workforce Commission , and Flagship furloughed employees and reduced employee wages, per KBRA. Flagship also recorded its lowest-ever auction conversion rate. A conversion rate refers to the ratio of vehicles that sell the first time they are auctioned. At GLS, proceeds from vehicle liquidation declined to 31% from 40% YoY. Payment deferrals have been on the rise, too. Flagship’s monthly extension rates, which typically hover in the 3%- 6% range, shot up to 9% in March and to 20% in April, KBRA noted. About 75% of the extensions — which enable borrowers to defer payments for 30 days while remaining in a “current” account status — were attributable to COVID-19. At GLS, extensions increased “moderately” in March and peaked to between 8.3% and 12.8% in April, according to KBRA. These extensions, combined with stimulus checks, have mitigated a rise in delinquencies and losses. In fact, late-payment rates have been slowing for some lenders. For example, Westlake’s delinquencies decreased month over month and extensions dropped from their peak in March, while GLS’ delinquencies declined from January through April, KBRA noted. Cash collections improved at First Investors Financial Services , too, as borrowers made loan payments with money from their stimulus checks and federal unemployment benefits. “Credit trends in the near term may be tracking better than expected, especially for auto and nonprime lenders,” wrote Jefferies analyst John Hecht in a May 26 research report. “We believe that loan impairments, or the combination of loans entering delinquency or requesting a modification, peaked in April and have been declining since. Delinquencies in certain asset categories, such as auto and certain bands of installment loans, are actually down year over year.” In the past few weeks, some lending indicators have improved. Westlake renewed two of its credit facilities, and Flagship resumed involuntary repossessions after a two-month hiatus. According to a mid-May survey of 846 used-car dealers, 63% of dealerships that had furloughed or laid off employees a month earlier had started the process of bringing them back, according to the National Independent Automobile Dealers Association . “Recovery and signs of life are showing, as 88% of dealers are open for business, with almost half open for business as usual,” said NIADA Chief Executive Steve Jordan . “Unfortunately, open for business as usual doesn’t always mean sales have returned.” In fact, used-car sales remain below pre-COVID levels for most dealers: 53% of NIADA survey respondents said their sales were down 50% or more for the previous two weeks. Restoring that vehicle sales pace is going to be critical for subprime lenders. Anecdotally, used-car sales have been outpacing new-car sales recently as consumers seek to limit monthly payments amid economic uncertainty. But the bulk of that volume is being generated by higher credit-quality borrowers. So, while subprime loan delinquencies are flat or declining for the near term, stalled originations — combined with the slowdown in extensions and the elimination of stimulus checks — could spur a spike in delinquencies come the fourth quarter. A key strategy for subprime lenders is to keep borrowers paying — even just a portion of what they owe — every month. Maintaining a dialogue with borrowers, standing by their side through the tough times, and offering grace on occasion will engender customer loyalty. Besides, with collateral values dropping and used-car demand dried up, lenders would do better limiting their auction volume.

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