Watch: What will it take to prop up subprime auto originations?

Subprime origination volume in the third quarter of 2020 continues to lag behind 2019 levels, driven by tightened credit boxes and inventory shortages, even as many lenders turn to digital financing solutions to meet consumer demand. But what pieces need to fall into place to help prop up subprime origination volume? In this episode of the Weekly Wrap, Amanda Harris, JJ Hornblass and Joey Pizzolato discuss the driving forces behind subprime’s slow recovery, what to expect from Axos Bank and Carvana’s new digital direct-lending partnership , and the new opportunities presented by the growing in-vehicle finance industry. Subscribe to The Roadmap Podcast on iTunes , Spotify , or download the episode. Auto Finance Innovation Summit, the premier event for technology in auto finance, returns March 16-17, 2021, as a virtual experience. The virtual experience will offer the quality networking and education of past events, all through an online platform. To learn more about the 2021 event and register, visit www.AutoFinanceInnovation.com . Video Transcript: Editor’s note: This transcript has been generated by software and is being presented as is. Some transcription errors may remain . JJ Hornblass 00:02 Hi, everyone. I'm JJ Hornblass and welcome to the roadmap from auto finance news, the nation's leading news provider on automotive lending and leasing. Thank you for joining us. This is our weekly wrapup for what's happening in the industry for February 22 2021. Before beginning a great thanks to our advertisers, Agora Data, Exeter Finance and Stook, Stook & Lavan. For their continuing support. I am pleased to be joined by Joey Pizzolato and Amanda Harris, from the auto finance news team. Welcome to both of you. First two general economic news. Brett oil climbed above $63 a barrel, as Goldman Sachs today predicted that prices could advance into the $70 range in coming months. On the Treasury's curve the gap between the five and 30 year yields touched the highest level in more than five years, which is a signal that investors expect a pickup of economic activity in the coming months. And banyoles also rose in Asia, but did edge lower in European trading. And finally, Bitcoin fell below $50 a coin after Elon Musk the car magnate suggested prices were too high at $58,000 a Bitcoin. And so we've got that new pricing in auto finance news. We had Westlake financial earnings that came out and showed that Westlake grew its portfolio by nearly 15%. In 2020. Let's start by talking a little bit about you know, kind of their financial performance. And I think it behooves us to also touch on their growth in the prime credit segment and then also sort of other developments in other credit segments, shall we say?Joey Pizzolato 02:34 Yeah, sure. I'll take that one. Right off the bat. So so like you mentioned, um, Westlake increase their their total managed assets to 12 point 1 billion, which was largely driven by an increase in prime credit chair. Now Westlake is a full spectrum lender for a long time, they really have their hands in pretty much everything as it relates to auto finance, they do commercial mortgages for dealerships, they finance branded cars, so they're everywhere, but but they have been making a stronger push into prime. So at the end of the year, there they have about 50% of their portfolio made up of prime. Now, they're usually known as kind of a subprime lender, but I think this is really kind of indicative of, you know, a larger trend that we've been following, um, that I'm sure Amanda will touch on a little bit more in a second. But sometimes losing losing quite a bit of market share as a result of the pandemic. lenders have pulled back, others, you know, we're seeing ally, they play in the subprime space, they're growing, Chase auto, they play in the subprime space, they're growing, but some of these smaller guys, they're having a hard time keeping up. And I think, you know, Westlake they kind of sit right in the middle of that, you know, they're not, they're not huge, but they're not tiny either. So so they could be a pretty good yardstick by which to measure which way the markets moving in terms of, you know, credit segment market share, JJ Hornblass 04:05 when you say, losing market share, what do you what do you kind of mean, what do you mean that there are fewer subprime originations being made? Joey Pizzolato 04:19 Yes, yes, when I say market share, subprime originations are down. JJ Hornblass 04:25 So you're saying the extension of credit to that. So it's not necessarily because you got to make this distinction, right. It's not necessarily that there are fewer subprime borrowers. It's just that there's less credit going to that face. I mean, do you have a sense or either review? I mean, do you have a sense for sort of the scope of that, like how much less? I mean, do we have a number for like, how much less subprime originations there has been over the last many months. Amanda Harris 04:59 Yeah, I can jump in on that. So we kind of push in on this issue a little bit more, through a report from TransUnion. This week that we had. And it really looked at, you know, again, that there was a pretty big decline. So, from their report, subprime originations declined about 21% year over year. And that comes as total auto originations are really kind of climbing back to pre pandemic levels, they were only down about 2%, from the same period a year ago, from that particular report. So that just kind of shows that wow, auto overall, you know, continues recovering, and everyone kind of has a pretty good outlook on and that it's coming back to 2019 levels, which are more of a normal, obviously, 2020 is more of an outlier now. But so price still is pretty pretty down. And I can go into a couple of reasons why we had a story back in December. So at the end of 2020, that really talked about, you know, subprime was falling to near Great Recession lows. So this kind of is an update on that, where it's still, it's still down. And part of that is, you know, there was a tightening of credit standards by lenders. So obviously, you know, there's less financing, maybe out there, at least from the traditional OEM type sources for those borrowers. But there's also, you know, just less demand. During this, you know, some of those borrowers may look toward, you know, refinancing, that's kind of something, we'll look into the next magazine, instead of going out to try to get a new vehicle for themselves, whether it's new or used. Some of it was just that maybe they weren't looking for a vehicle, and maybe they focus on some other, you know, debt, trying to pay off debt, trying to, you know, pay the regular bills at this time, you know, a lot of people still were on for low unemployment, you know, some of the assistance programs have ended. So all that kind of goes to say that those borrowers, one may or may not, may just not be looking for those, and then to, you know, might not be able to get the financing from more traditional sources. That's not to say there is a financing out there, there's always going to be someone who wants to borrow to give them money. If they would like to borrow money to purchase a vehicle, they're going to be able to find it, but just JJ Hornblass 07:20 I mean, you have to you have two underlying factors. And let's just state one thing. I mean, in the subprime sector, the main motivation behind purchase, generally, is work related. I believe that that's that that has certainly historically been the case. My sense is, it would still be the case, I don't see why wouldn't. So if you've got historic unemployment, and you've got historic work from home, then, you know, the demand for a vehicle is just not there in a segment that doesn't have this sort of nice to have motivations in the luxury car space, luxury slash primes. But so. So you know, that the issue to me is is to what degree might inflation drive, subprime originations, what I mean by that is, is that if you are in an inflationary circumstance, then you need yields to be as high as possible, because you got to keep pace with the inflation that is sort of underpinning already or that is running as an undercurrent to to credit. Um, so I mean, I guess at what point does that happen? Or is that not even really, let's say a consideration? Joey Pizzolato 08:52 I mean, I think with with the benchmark being as low as it is in the feds forecast, it's enough to not raise that. I think it's probably not a major concern right now. But I definitely think, you know, that with with the Fed's monetary policy, being really unable to kind of like pin down even if you know, 2%, inflation is kind of their target anymore. You know, that that could change on a dime, especially in our current economy. I think one other thing we also have to remember, I totally agree with what you said, JJ, but I think in terms of, you know, consumers and in the subprime space in their jobs, um, you know, you have, you have a lot of service industry workers, a lot of restaurant workers, factory workers, fulfillment centers, and a lot of those people, you know, don't have the option to, to work from home. Right. So, you know, while on one hand, yes, absolutely. I agree. That, you know, work from home changes demand in terms of how many vehicles a household needs, how many miles are going on those vehicles. I do think in the subprime space You know, I think origination or the lack of originations is probably more driven by, you know, lenders being more risk adverse than they were, rather than, you know, dwindling of demand. Not Not to say that that's, you know, not a factor in some, some sense. Amanda Harris 10:19 Just to add to that, that another factor, so there's like multiple factors in this, but it was inventory. So we know that, you know, inventory has been kind of struggling to come back. And then that means that there's obviously fewer vehicles on the lot. And even you know, we know subprime borrowers typically go toward these vehicles, there was even more use less use vehicles available to them. So that just might mean that their car that they were looking for in the price range they wanted, because they shot by monthly payment, typically, you know, just may not have been available, either. They may not have been able to purchase a car because what they were looking for, and what they needed, and the price they needed, was unavailable, because inventories been short lived. So it's just another thing too, that could be driving some of this kind of lag that we're seeing. JJ Hornblass 11:04 Right. We had also, I recall, the three of us talking and, you know, kind of the fall, we had spent a few podcast episodes talking about the upcoming wave of credit deterioration that was expected. And as I recall our conversations we had expected that to take place. Well around now. Right. I mean, about about about this point, you know, that that also could have? I would think I mean, correct me if I'm wrong, it could have also played into it were into the considerations on registers the Well, we're heading for a, you know, a poor credit environment, credit performance environment. So let's just hold off on originations now. And and kind of save it for when the market maybe returns, which I think well, first of all, I don't know, if you disagree, welcome to, you know, we could talk through that. I mean, but it to me, it does imply that that 21% decline, that, that you mentioned, Amanda, you know, my sense is, is maybe second half of the year, you're talking about not just a 21% growth rate, but maybe even you know, 30 or 35% growth rate in that, in that credit tier. What What do you both think of that argument? Joey Pizzolato 12:35 I mean, I agree, right, like, like, the last last quarter, pretty much. We were constantly talking about, like you said, When is the credit deterioration coming? When can we expect it first it was q1 now it's like, oh, maybe maybe q2? Well, I mean, I guess the point is, we're, we've kind of hit hit these benchmarks when we said it's coming, and it's still hasn't really come like worse. Yes, we're seeing seasonal uptakes, in in delinquency rates, net charge offs are still well below what they were, you know, a year ago. So, you know, at some point, you're right. lenders are gonna say, you know, the worst is behind us. And, you know, I think we can start getting more aggressive. And I think, you know, by by the second half of the year, you know, if everything continues on its current trajectory, we could be well positioned to see that happen. JJ Hornblass 13:27 Unless it's a demand dynamic, Joey Pizzolato 13:30 of course, or an inventory issue in which the market can't can't meet, meet. JJ Hornblass 13:35 Right. meet the demand. Yeah. Okay. Let's talk about the access carvana partnership. Um, so why was this a significant partnership? Joey Pizzolato 13:49 Well, you know, I'm exos, to be fair, is is a pretty small lender, right? They have about 260 million in auto outstandings. But I think the partnership is really indicative to the entire movement of the industry. We've talked a lot about, you know, these JJ Hornblass 14:07 models, let's say what the partnership was, Oh, Joey Pizzolato 14:10 yeah, sure. That's probably good idea. So axos has has a partnership with our carvana, in which it's direct its direct consumers on access website will be redirected to a co branded page on carvana. So basically, they get to shop for cars on hermanas inventory, and then access we'll find them with a direct to consumer loan that they are pre approved for similar to partnership regions bank, which exited indirect auto in 2019. I believe they have with carvanha, where their direct loan consumers get redirected to carvana website that would co brand new page. So that's the partnership. Pretty simple, straightforward. But like I said, I think it's pretty indicative of, we've been seeing larger lenders kind of moved to this digital first, Ford started its online CPO program during the native show, or announced it rather. And now we see access bank, which, like I said, is a relatively small auto lender still making this move. So I think I think what we're gonna see more and more this year is even even some of the smaller lenders with portfolios in the hundreds of millions really make this this push to digital financing and digital retail. JJ Hornblass 15:34 I mean, isn't it also more about maybe carvana kind of using a smaller lender as a as a beachhead to establish more financing arrangements with other lenders, larger lenders easier to sort of start small and work your way up? Joey Pizzolato 15:56 Um, yeah, you know, I don't see why why wouldn't be? I'm not I'm not sure. 16:04 So Joey Pizzolato 16:06 what do you mean by is like, is there establish a relationship? JJ Hornblass 16:11 Well, they there, aren't they? They're, they're providing the financing correct. Joey Pizzolato 16:18 Well, accesses is doing JJ Hornblass 16:20 access is providing the data. So you know, for So first of all, I mean, for access this is, I would think this is going to just turbocharge, it's originations. Like, it's, you know, unbelievable. I mean, what's the volume of car sales at carvanha? these days? Joey Pizzolato 16:39 Um, we don't have the latest retail sales, they haven't reported their earnings yet, but I couldn't figure out how many they sold last in q3. JJ Hornblass 16:50 Yeah, so, you know, you know, that I mean, this is maybe the kind of thing where, you know, carvanha may eventually acquire access. So they're selling about, they're selling about 180,000 vehicles. It will just 2019. So probably 2020 was, I would guess, similar, maybe a little more, Joey Pizzolato 17:28 probably higher, considering they had a huge jump during the pandemic, at the height of it. JJ Hornblass 17:34 So maybe 250,000 units. 17:38 B. JJ Hornblass 17:41 It could be whatever the case may be, I mean, you know, this is like, you know, they did, either they can, you know, kind of take a smaller lender and, and make their business, or it's like, they establish a relationship with one small under and then you can have multiple financing partners. And I know, they have another one on the prime side. Right. With, with regions. 18:06 Yeah, regions, regions. JJ Hornblass 18:09 But, but anyway, you know, a prelude to maybe kind of, you know, additional developments on that front, at least for carvanha or digital financing. Joey Pizzolato 18:20 Well, yeah, absolutely. And, you know, from carvana point of view, the more the more of these small partnerships, they they get, where, you know, the financing is pre approved by by a third party lender, and they're, they're funneling their those customers into carvana. Um, you know, that that's just a boost for them in their retail sales, which is really their bread and butter, right? providers, not super interested in the financing. They, you know, they finance and then they they pass that off to ally or they securitize it, take it off their balance sheet. So, so a similar similar approach to this to their direct to consumer partnerships that they have where, you know, funnel sales into form on this platform, but keeps those loans off their balance sheet. And I'm elss. JJ Hornblass 19:06 Right? I mean, this could this could maybe drive I mean, what do you think? Do you think maybe a billion of originations and accents Joey Pizzolato 19:17 that that might be a tall order, cuz they did their their private so they weren't able to disclose their origination volume, but I would imagine with a outstanding portfolio of indirect and right they haven't been indirect before this is their a new thing for them. But I would imagine with 260 million in indirect outstandings, you know, their originations are not even anywhere close to a billion. So with, you know, a couple that with the fact that their direct program is brand new, it's still in pilot, you know, potentially in a couple years, maybe. But you know, that that is quite quite a lot. JJ Hornblass 19:57 The speaking of digital finance Amanda, you did a great piece on in vehicle financing or the development of in vehicle financing. Maybe share with us a bit of background on that some quick background? And then, you know, really the question that I think bears asking is, why is there this, this sense that financing will be in vehicle and not via mobile device, like why the why the vehicle versus the mobile device? Amanda Harris 20:39 Sure, um, so the background is, you know, connected cars obviously has become kind of the new thing, it's kind of becoming the more normal, you don't really get many new cars. Now, without that digital screen, that nice big touchscreen, and, you know, all the abilities to have all your apps and stuff right into your car. So, you know, this kind of in vehicle financing trend really comes out of that, you know, as cars become more connected, people want to do more and more, easier and easier and quicker and quicker, right. So the idea of in vehicle financing is basically using your car as kind of the mobile device. So when you pull up to the gas station, right now, you can easily you know, have your apps integrated, you have your, you know, show whatever you typically use in the cars, you know, digital kind of system. And so then you can easily use the app within the car, you know, to pay for gas to pay for food, you know, anything like that. So it's basically using your car as kind of that payment vehicle. And the reason we're kind of moving more toward that versus a phone, it's just, it's a little easier, right? It's a little faster, it's, you don't have to bring your phone out to, you know, pull up the app and all that stuff, they're really going more toward you can pull into a gas station car will automatically pay for the gas, you know, right now, you still have to kind of hit a button that says Yes, go ahead and do that the apps already integrated. So the car is not, you know, paying for it, it's integrating into an app that is connected to your payment or whatever. But it's basically just making that whole process easier and quicker, because that's what we want as humans, right, we're really like about Instagram application, we want it to be quick. And anything that can make it even two seconds faster, we're on board. So I think that's really more where it's going, just trying to make all that easier and using the car as a way to do that. And for OEMs, that benefit is really, obviously, if you can have your car do that that's more appealing to a customer that's looking for more of that luxury and ease. And then also, it's a chance to kind of build some loyalty and gives you another way to connect with customers literally right there in their, in their car on the screen. It's a couple different benefits into why this is kind of becoming old. JJ Hornblass 22:49 Do you see this kind of developing as more of the realm as within the realm of the captive finance company, you see, like kind of the captives handling, you know, they handle the lending, they handle the leasing, but now they're going to handle you think like kind of the in vehicle payments finance transactions, too. Amanda Harris 23:15 I don't think it's so much on for car payments, you know, right now, it's really more for, for using it for things like Like I said, food and gas and things like that. So the, it's really more of an OEM thing, the cactus will benefit just because obviously, if you drive up more loyalty, customers keep coming back to keep purchasing at the General Motors car, for example. That's another way to kind of reach them to and, and one of the things I mentioned is they could use that as a way when you pull into a dealership to say, hey, do you know we have like these great financing deals going on. So it's another kind of advertising Avenue, but it's not so much built for, you know, making your car payments, it's really more as a luxury kind of benefit to having that digital capabilities in the car and using it more in your everyday life. Yeah, Joey Pizzolato 24:05 so just real quick, 24:06 go please. Joe. Joey Pizzolato 24:07 Um, you know, one thing, General Motors said, Scott Goddard, when we when we spoke with him for this feature was General Motors has no interest in getting into the payments, right? So that back end everything that comes with that, they're not interested in that. It's It's messy, right. So they let the retailer handle the payments. So in that case, right for General Motors slash GM financial, I don't think we will see a situation in which GM financial manages those payments and, you know, takes that under under its hood. But that's not to say that another lender could structure that the vehicle payments in such a way. Right. I JJ Hornblass 24:51 mean, some of the captives do have bank charters, so they would be able to facilitate the payments to some You know, to some degree, and there are, I mean, I think, you know, famously, there's a sort of undervaluing of the risk management that underpins some of the digital payments providers. PayPal is one that comes to mind, you know, the, the, the risk management that is entailed and implemented the delay between transaction may transaction received kind of thing. So, you know, I, you know, they the captives do have financial sophistication, but, you know, as you say, Joey, if it's, if it's too messy, then maybe they were but you know, I don't know, I wonder whether they're, you know, at some point, if you if you see the financial opportunity, and you have a financial operation or infrastructure, you know, whether that might lead to more engagement with in vehicle financing. 26:09 I think I think it would. JJ Hornblass 26:12 Okay, so this, what do we have coming up on on the site in the coming days? Joey Pizzolato 26:17 This week is afsa virtual conference. JJ Hornblass 26:22 Okay, I'm so we are done? Are we done with earnings? Joey Pizzolato 26:26 Um, pretty much room and shift in carvana. Report early in March. So we'll have a couple trailers coming up, but for the most part, we are done. JJ Hornblass 26:40 Okay, good and see the ABS event. And we also do have our auto finance Innovation Summit that is coming up at some point or other, so people should check that out. When is it again, are the 16th and the 17th March 16 17th. So people should check out auto finance innovation calm to register and other registrations have been very strong for the event. And certainly follow us on Twitter, and LinkedIn. And visit us at auto finance news. dotnet Amanda and Joey, thank you so much. And thank you all very much for for joining us. We'll see you next time.

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