Subprime Rising: How lenders are trying to dig out from the pandemic recession [Feature]

In late February, the financial department at Westlake Financial Services noticed something interesting: A few key words kept resurfacing during calls with customers. “We started to look at, ‘How often are they mentioning ‘coronavirus’ or ‘unemployment’ or ‘fear’ or ‘furlough’?” said Sean Morgan , Westlake’s vice president of finance. On Feb. 25, weeks before the spread of COVID-19 spurred states to shutter businesses nationwide and force consumers to stay home, the company’s head of IT sent an email to senior leadership “to let them know it is not looking good and we need to be prepared to work from home,” Morgan said. Westlake had used CallMiner , analytics software that translates phone conversations to text and monitors word frequency, to plan reactions to catastrophic events like Hurricanes Harvey and Irma. The COVID-19 pandemic was no different; the software helped Westlake track consumer sentiment and put a strategy in place weeks before masks were mandated and the economy hit pause in mid-March. “Numerical data alone can tell you a lot, but it can’t tell you the tone,” Morgan added. Westlake is not alone in reexamining its operations. After a bright 2019 for lenders — particularly subprime lenders, who outpaced banks, captives and credit unions in new loan growth — the future looks less assured. Less than three months into the new year, the arrival and spread of the COVID-19 virus in the U.S. set off an unprecedented economic standstill, halting a high-flying decade of new- and used-vehicle sales. Claims surged beyond 30 million, eclipsing even the fallout from the Great Recession. Meanwhile, car dealerships closed, auto plants idled and investors began shying away from asset-backed securities, spelling a potential liquidity loss for lenders. The jolt especially squeezed subprime borrowers furloughed or laid off from jobs in retail, restaurants and other service-based businesses. Amid drastic change and lingering uncertainty, bills for emergencies and routine payments alike hit many borrowers hard, especially those without savings to weather a loss of regular income. To adapt, the nearly 30 national and regional subprime lenders in the U.S. are deploying a variety of strategies including extending deferrals, halting loan originations, pulling back on repossessions and streamlining internal operations. “Lenders are really in a defensive posture, focusing all of their resources right now on managing their portfolios,” said Michael Buckingham , managing director of PIN Auto Finance at J.D. Power . “Some are being very aggressive, some are being passive.” Many lenders began granting payment deferrals to customers once the pandemic hit. For most of them, “the phone lines have been ringing off the hook,” Buckingham said. First Investors Financial Services attests to receiving “higher than normal call volumes.” “At this time, we are having to prioritize accounts and are focusing on accounts that are seriously delinquent in order to assist those most at risk,” according to a posted on its website. The company also says it will waive late fees for customers who call and make a payment. The strategy for most lenders is to keep the borrower paying, even just a portion of the amount owed, every month. The leniency bolsters the companies’ cash flow and builds customer loyalty in anticipation of flusher times, said Buckingham. Westlake began contacting customers in early March to discuss partial payment plans and deferrals on their monthly payments. Roughly half of its customers have Fico scores below 600. As a result, Westlake’s extensions peaked in March but returned to normal year-over-year rates by June. Global Lending Services and Flagship Credit Acceptance also reported a rise in deferrals and a decline in delinquencies during the first half of the year. The deferrals and extensions mean that many lenders expect to collect less during this period. Credit Acceptance Corp. reported in its May 27 first-quarter earnings release that it expects to collect payments on just on its consumer loans, the smallest percentage since at least 2011. “We had obviously lower collections in March,” Chief Executive Brett Roberts said during the company’s earnings call. “Second half of March, in particular, people weren't making their payments… It's going to reduce the estimated cash flows for the life of that loan.” One Main Financial nearly doubled its finance receivable losses to $530 million for the first quarter of 2020, up from $276 million during the same period last year, “primarily as a result of the impact of COVID-19 on our macroeconomic outlook,” according to its first-quarter earnings. First Investors Financial Services and other lenders report that the arrival of federal stimulus checks and unemployment benefits boosted cash collections. Meanwhile, lenders are also pulling back on repossessions, a tactic that can polish a company’s public perception in tough times while staving off accounting losses. That’s because “99% of the time when you repossess a car, you lose money,” Buckingham said. “Plus, the auction market is weak right now, so you can’t get as much money for it anyway.” However, postponing repossessions is only a temporary fix. “Clearly there is a plethora of vehicles that will be repossessed in the coming months when things start to settle down,” he added. Most lenders have halted sales and marketing efforts to acquire new customers. Their loan origination rates have dropped as they focus on managing their current portfolios and working with existing customers instead. Credit Acceptance Corp. and Consumer Credit reported steady improvement in new loan volumes after plummeting in March. Year over year, Westlake’s originations fell 43% in April before surging 37% in June due to pent-up demand, cash from federal stimulus checks and unemployment benefits, and dealership re-openings. Overall, Big Wheels Auto Finance Data 2020 forecasts a 40% plunge in origination on an annual basis, the steepest single-year decline in two decades. The seasonally adjusted annualized rate, or SAAR, for new vehicles nearly halved in April, to 8.6 million units. The rate improved in May to 12.2 million, still far below the 17 million units projected in January prior to the pandemic’s stateside arrival. Compared with the fallout from the Great Recession just over a decade ago, the economic effects of the COVID-19 pandemic are swifter but expected to be less drastic over the long term according to Buckingham, who helmed Hyundai Capital at the time. “That was death by 1,000 stab wounds,” he said. “With this, we went from really good to terrible in 30 days.” For now, “capital markets are open and it’s a lot easier to get liquidity than it was then,” he said. Captive financiers such as Ford Motor Credit and GM Financial likely have enough liquidity to survive the pandemic, but some analysts say that small subprime lenders could face pressure to consolidate or close for business. Even Wells Fargo Auto , the nation’s eighth-largest auto lender according to Big Wheels data, made headlines in May when it announced plans to exit the subprime space and scale back funding to independent dealers. Meanwhile, additional signs of instability for the subprime auto loan market abound. Santander Consumer USA , the country’s largest subprime auto financing company, reached a $550 million settlement with 34 states for its role in deceptive loan practices. The settlement, which stemmed from subprime lending practices dating back to 2010, was unrelated to the COVID-19 outbreak but dealt a blow to the business at an inopportune time. Across the board, lenders are now tightening underwriting standards and requiring more stringent proof before verifying a potential borrower’s income and state of residence. But some subprime lenders are hoping to capitalize on this pent-up demand by courting new customers. Auto Credit Express , which lends to a nationwide “network of special finance dealers,” invites potential borrowers to apply online. According to its website, Auto Credit Express will “review it without pulling your credit score and send it to the nearest dealer that matches your credit profile.” Finally, lenders are streamlining internal operations. Nicholas Financial furloughed about 40 workers but said it brought them back after receiving a $3.24 million loan through the federal Paycheck Protection Program, designed to help businesses with fewer than 500 employees stay afloat during the pandemic. The company expects brighter days ahead. “For a significant majority of our customers, the financial impact of the COVID-19 pandemic has been minor or even nonexistent,” Doug Marohn , chief executive of Nicholas Financial, in a letter posted on the company’s website. Other lenders are following a more nuanced line. “We’re cautiously optimistic, but no one knows where this is all going to go,” Westlake’s Morgan said. “We’re monitoring this closely, but we’re not out of the woods until there’s a vaccine.” Editors Note: This feature first appeared in the July issue of Auto Finance News , available now . Auto Finance Summit, the premier industry event, returns October 20-22, 2020, as a virtual experience. The virtual experience will offer the same quality networking and education as past events, all through an online platform. To learn more about the 2020 event and register, visit www.AutoFinanceSummit.com .

Subprime Rising: How lenders are trying to dig out from the pandemic recession [Feature]

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