CHP Consulting US Auto Finance Market 2015 · and accounting of a wide variety of finance products; and combined with our unrivalled track record of delivering solutions on time and

CHP Consulting US Auto Finance Market 2015: US auto finance market gets its house in order

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Acknowledgements

Darrin Benhart, deputy comptroller for supervision risk, Office of the Comptroller of the Currency;Richard Cordray, director, Consumer Financial Protection Bureau;Cristian deRitis, senior director, Moody’s Analytics;Vanita Gupta, acting assistant attorney general civil rights division, Department of Justice;Bill Himpler, executive vice president American Financial Services Association;John Humphrey, senior vice president global automotive practice, J.D. Power;Egil Juliussen, director, research, infotainment and advanced driver assistance systems, IHS Automotive;Thomas King, senior director, J.D. Power and Associates’ Power Information Network;Chris Kukla, senior vice president, Center for Responsible Lending;Jason Kulas, CFO ,Santander Consumer USA;Jason Laky, senior vice president and automotive business leader, TransUnion;Eric Lyman, vice president of industry insights, TrueCar;Jared Rowe, president, AutoTrader.com;Jeff Schuster, senior vice president of forecasting, LMC Automotive;Peter Welch, president, National Automobile Dealers Association;Melinda Zabritski, senior director, Experian Automotive.

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Contents

Summary 4

Introduction 5

Credit crunch 5

Green light for go 7

Prospects ahead look bright 8

Amber light for warnings 9

Sub-prime worries 9

Loan terms lengthen 10

Loan distribution stable 11

Delinquencies stay flat 13

Leasing remains dominant 14

Red light for regulations 17

Lease accounting 17

Past misdemeanours 17

Discriminatory practices 18

Race and ethnicity 18

Military personnel 19

Consumer Financial Protection Bureau 20

Auto loan scrutiny 20

Stronger CFPB powers 21

Loan discrimination methodology 22

Changing face of the consumer 23

Self-driving cars 23

Millennials rev up car buying activity 24

Conclusion 25

Risk vs Opportunity 25

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US auto finance market gets its house in order

Summary

Heading into 2015, US car sales are on course to reach levels not seen since the early 2000s, well before the financial crash and credit crunch which wreaked such havoc in the auto lending market. A buoyant US economy, low gas prices and a sense that a difficult few years are now behind them has driven US consumers to look once more at buying vehicles.

For dealers and the auto finance providers who supply the money which keeps the wheels of the market turning, it may seem that it is “business as usual” at long last. But the road ahead is by no means straight and narrow.

Amongst the obstacles strewn along the way are a raft of regulatory challenges. Government agencies formed to help consumers bruised by loans taken out on unfair and often crippling terms are turning their attention to the auto lending market. Some of the biggest names in the business have faced claims that their lending practices were discriminatory, with heavy fines and substantial redress for consumers now in prospect.

Lenders are also finding the market is re-shaping, with banks and captives re-thinking their strategies. As loan lengths tick up and activity increases in the sub-prime segment, so commentators are starting to voice concerns about poor-quality lending practices.

The peaks in car production volumes are still there, but now sharing resources and online selling have become part of the picture for a new generation of young buyers who are less interested in owning a car all to themselves and more interested in accessing a range of mobility services.

And still casting its shadow over this entire picture is the long-debated issue of changes to lease accounting rules. That these are coming is not in doubt, but there is still no certainty as to how they will impact on the auto finance industry in the US.

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Introduction

The US is the birthplace of the automotive industry and car ownership has come to represent a critical element of the American dream. Consumers’ love affair with their automobile has seen the US become the largest and most mature market for auto finance and leasing worldwide, as manufacturers, lenders and dealers have worked together over the decades to develop innovative solutions to grow the market.

Data from the Federal Reserve Bank of New York shows that auto finance is the third-largest household credit market in the country, ranked below mortgages and student loans.

Other than bank accounts, vehicles are Americans’ most common asset, with roughly 86% of families owning at least one vehicle. According to the US Bureau of Labor Statistics, transportation is often the second-largest expense that families face after putting a roof over their heads.

The National Consumer Credit Trends Report published by Equifax puts the total balance of auto loans in December 2014 at $975 billion, an increase of 9.3% over 2013. Auto lending now accounts for a third (33.2%) of total outstanding non-mortgage consumer debt, the credit rating agency calculates.

There is little doubt about the importance of the car to the US economy and to individual US households. Most consumers who buy cars need to finance at least part of their purchase rather than buying it outright – 84% of new car purchases and 55% of used car purchases involve financing, according to market research from Experian’s automotive specialists. That translates into a large and very active auto lending community.

Credit crunch

That close relationship between US consumers and their cars hit a major barrier in the 2008 financial crisis, when a toxic combination of loans gone bad, difficulty in obtaining credit and an economy in freefall had a profound

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effect on the market. Lenders and dealers found it increasingly hard to raise funding, making it much more difficult to offer enticing rates on loans and leases. In any case, consumers who were fearful of what might happen to their jobs were reluctant to take on any additional debt, particularly as wages started to stagnate.

Sales of new cars slumped, as potential buyers could not find the money to finance a purchase, or were so unsure of what the future might bring that they put all financial decisions on hold. Lenders found that default and repossession rates started to rise sharply, as cash-strapped car owners saw their monthly budgets squeezed, and used car residual values fell, disrupting lender leasing models.

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Green light for go

In contrast, the current picture for car manufacturers and dealers is looking much rosier. Sales of new cars have been rising steadily for the past two or three years, driven by a stronger economy, greater consumer confidence and the wider availability of credit.

According to the 2015 Automotive Buyer Influence Study from IHE Automotive, the fourth in an annual research series for the website Autotrader.com, some 61% of new car buyers in the US last year maintain they purchased their latest vehicle due to a “want” rather than a “need”.

Jared Rowe, president of AutoTrader.com explained: “This is another great indicator for the overall state of the automotive industry. When consumers start to make big purchases out of desire rather than necessity, they are clearly showing more confidence about their personal financial situations.”

The study, which surveyed over 2,300 new and used car buyers, found the majority of new car buyers (64%) researched vehicles first, and then set their budget, further suggesting they are now not feeling as cash strapped as they likely were in previous years.

Other sources back up the view that money is now flowing into the auto market. The J. D. Power and LMC Automotive Report looking at vehicle sales forecasts for 2014 and 2015 predicts that total light-vehicle sales are likely to hit 16.5 million in 2014 and reach 17 million in 2015.

The end-of-the-year monthly sales forecast for December 2014 suggested new-vehicle retail sales had reached the highest levels on a seasonally adjusted annualized rate (SAAR) basis since 2006, at 1.3 million units. This marks a 7% increase compared with December 2013.

The retail SAAR in December 2014 is expected to be above the 14 million unit level for the third time in 12 months, with a rate of 14.2 million units, which is 1.4 million units stronger than the equivalent month the previous year. In comparison, the most recent month in which the retail SAAR was 14.2 million units was in August 2006.

US Retail SAAR—December 2013 to December 2014 (in millions of units)

Source: Power Information Network (PIN) from J.D. Power

US Retail Light-Vehicle Sales

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“The industry continues to demonstrate strong sales growth as the year comes to a close,” said John Humphrey, senior vice president of the global automotive practice at J.D. Power. “The end of the year typically drives more showroom traffic as customers seek to take advantage of better deals used to clear out inventory in preparation for the New Year.”

Total light-vehicle sales in December 2014 were close to 1.5 million units, a 6% increase, compared with December 2013. Additionally, LMC Automotive has raised its retail sales forecast for 2015 to 14 million units from 13.9 million and increased its total light-vehicle sales forecast to 17 million units from 16.8 million.

J.D. Power and LMC Automotive US Sales and SAAR Comparisons

December 2014 November 2014 December 2013

New-Vehicle Retail Sales 1,265,000 units

(7% higher than December 2013)

1,094,858 units 1,139,868 units

Total Vehicle Sales 1,498,200 units

(6% higher than December 2013)

1,299,474 units 1,357,044 units

Retail SAAR 14.2 million units 13.7 million units 12.8 million units

Total SAAR 16.7 million units 17.1 million units 15.4 million units

Prospects ahead look bright

Speaking at the end of last year, Jeff Schuster, senior vice president of forecasting at LMC Automotive, said: “The prospects for auto sales to overachieve in 2015 are moving closer to reality as 2014 goes out on a high note. Economic bliss, driven by job creation, wage growth and low gas prices may drive consumers to showrooms at a faster pace, emphasizing the notion that this recovery may not be over quite yet.”

The New Year has not disappointed, with analysis showing US auto sales began 2015 much more strongly than they did in 2014. January light-vehicle sales were around 13% higher than a year ago, according to TrueCar.com and Kelley Blue Book. LMC Automotive projects a 12% increase, which would represent the industry’s biggest year-over-year jump since August 2013.

TrueCar analysts said sales are still tracking toward a full-year total of 17 million, a threshold last crossed in 2001.

“With solid economic expansion underway and consumer-friendly gasoline prices, the auto industry remains a high-growth sector,” Eric Lyman, vice president of industry insights for TrueCar, said. “Other indicators signaling a home-run year for the industry include the recent high in US single-family housing starts and pre-recession unemployment levels.”

Excluding fleet vehicles, the retail SAAR is expected to be 13.9 million in January, compared to 2014 retail sales of 13.6 million, confirming the strength of the market, LMC said.

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Amber light for warnings

Annual US new-car sales are now 58% higher than they were in 2009, at the low point of the auto industry crisis caused by the great recession. After the years of austerity, most observers would agree that booming car sales are a welcome development.

But throughout 2014 commentators have started to question whether it is possible to have too much of a good thing, and whether dealers and finance sources are starting to introduce new practices which could see a resurgence of some of the severe financial problems which dogged the auto lending market back in 2008.

Then, loosening of underwriting controls saw an increase in sub-prime loans to consumers with poor credit ratings, who were in trouble as soon as the recession started to bite. For the next six years, the only consumers able to access auto finance were those with the highest credit scorers, with sub-prime borrowers out of favour and out of luck when it came to getting a loan. But more recently, credit has become more accessible and loan rates have been relatively low.

Sub-prime worries

Now, the Center for Responsible Lending (CRL), a not-for-profit organization which looks at household finances, has signalled its concerns over whether the pendulum is swinging too far in favour of those with less than pristine credit histories.

In a report released in January 2015, “Reckless Driving”: Implications of Recent Subprime Auto Finance Growth, CRL points out that in Q3 2014, nearly 39% of open auto loans worth $337 billion were for customers with below-prime credit. That marks an increase from $304 billion owing in the sub-prime category in 2013 and just $255 billion in 2012.

This trend has also been observed by the Federal Reserve, which stated: “The dollar value of originations to people with credit scores below 660 has roughly doubled since 2009, while originations for the other credit score groups increased by only about half.”

In addition, the Federal Reserve’s data suggests that in tandem with an increase in the number of auto loans made to borrowers with poor credit histories, more individuals are having problems with auto loans, pointing to a rise in the delinquency rate in late 2014 to 3.5%, from 3.1% in the previous quarter.

The CRL report claims lenders are loosening underwriting standards and extending loan terms while increasing auto loan amounts, which it says is increasing the risk of defaults, particularly for sub-prime auto loans. While delinquency rates are only marginally up, the consumer organization says that statistic overlooks the growing numbers of consumers who are simply handing cars back to lenders.

It points out that in every quarter since Q3 2013, repossession rates have been significantly higher than the same quarter in the previous year, while the Q2 2014 repossession rate was 70% higher than at the same point in 2013.

“Those who have expressed concern about the auto lending market have reasons for that concern,” Chris Kukla, a senior vice president with CRL, said in the report. “Underwriting standards in the sub-prime market have deteriorated, while practices in the market, like interest rate mark-up and the sale of add-on products, can make loans unaffordable.”

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Loan terms lengthen

Warning bells have been sounding at an official level, too. In a speech to the conference of the Global Association of Risk Professionals in New York in February 2015, Darrin Benhart, deputy comptroller for supervision risk at the Office of the Comptroller of the Currency (OCC), singled out the current auto finance market as a cause of concern.

Benhart said OCC research suggested ongoing earnings pressure is causing some banks to reach for yield and take on additional strategic risk, while there are signs that competition for the limited lending opportunities that exist in the current market environment is intensifying and resulting in weaker underwriting standards, particularly in indirect auto lending, as well as leveraged lending, and commercial and industrial loans.

As a result, risk is rising as auto lenders extend loan terms, more loans go to consumers with low credit scores, and loan-to-value ratios become higher. Benhart pointed to data suggesting lenders are now extending repayment periods up to 84 months on new and used vehicles, compared with the 60 months seen traditionally. He said the OCC is starting to observe deterioration in auto lending portfolios, and banks are seeing the average dollar losses per vehicle rise.

In the past two years, the share of 73-month to 84-month loans for new cars has doubled as a percentage of the total market, from 12% to 24%. The share of long-term loans for used vehicles also doubled from 7% to 14%.

“Let that sink in for a moment,” Benhart said. “That means it is not uncommon today for a family with subprime credit to take a loan at 110% of a used car’s value that they will be paying off for seven years. That means if the family bought a used car on these terms when their daughter celebrates her ninth birthday, they will still be paying for it when she takes it for her first drive on her 16th birthday.”

Not every auto lender is on board with seven-year loans. For example, Volvo Car Financial Services, Nissan Motor Acceptance Corp. and Ford Motor Credit Co. have all said they do not offer 84-month loans, in part because they want customers to return to the trade cycle more often.

But Toyota Financial Services has been offering 84-month loans since 2007, although these account for less than 3% of volume. Ally Financial started rolling out 84-month loans to relatively well-qualified customers nationwide in February 2015.

At the same time that the auto-lending product profile has started to change, tools used by banks and others to underwrite loans and qualify borrowers have also changed. Credit ratings now exclude or downplay the impact of certain debt, such as medical debt. While the changes in the ratings may be warranted, Benhart cautioned banks must understand what these changes mean relative to evaluating a borrower’s total ability to manage new debt.

“So far, rapid growth in auto loan volume and low payments have offset the full impact of the risk by masking delinquency and loss rates as a percentage of total volume,” Benhart said. “We will have to wait and see how those investments perform over time, but institutions should take care to manage these risks carefully.”

Darrin Benhart, deputy comptroller at the Office of the Comptroller of the Currency (OCC)

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However, both the OCC and the CRL readily acknowledge that it is not necessarily true that because increases in sub-prime lending heralded problems in 2008, they will inevitably do so again almost a decade later.

Loan distribution stable

Certainly, the latest data from Experian Automotive, which has been tracking the market in depth for all of that time, suggests that some of the current worry may well prove to be misplaced. According to its report on the state of the automotive finance market in Q4 2014, the total for outstanding auto loan balances has hit an all time high of $886 billion, 10% up on the 2014 total for the same period and 11% up on 2013.

6 © 2013 Experian Information Solutions, Inc. All rights reserved. Experian Public.

A look at automotive loan balances

Source: Experian-Oliver Wyman Market Intelligence Reports Source: Experian-Oliver Wyman Market Intelligence Reports

Outstanding automotive loan balances


Open loan overview

Source: Experian-Oliver Wyman Market Intelligence Reports

Super prime Prime Nonprime Subprime Deep subprime

Risk distribution of open loans


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“There has been growth across all the risk ranges as the volume of loans increases, but it is important to note that the distribution of loans is stable,” says Melinda Zabritski, senior director Experian Automotive.

“In fact, comparing Q4 2013 to this year, there has been no change in the proportion of loans in the deep sub-prime category, which stands at 3.75%, and sub-prime has actually dropped a little. The largest volume gain is in super-prime.”

Zabritski says the data shows the below 600 credit score level of borrowing is decreasing year on year as a percentage of the total, consistently hovering at around the 20% mark.

Melinda Zabritski, senior director Experian Automotive


Recent automotive delinquency: 30 day delinquency



Recent automotive delinquency: 60 day delinquency


30-day delinquency

60-day delinquency


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Indeed, GM Financial and Santander Consumer USA, two traditional sub-prime specialists, have recently indicated they are accelerating strategic moves up the lending chain into prime-risk loans and leases in 2015.

GM Financial originated about $500 million of loans in the prime sector in 2014, compared to just $120 million the previous year. It also has a 47% share of lease originations for parent company General Motors, up from 15% a year earlier, and the vast majority of these are prime.

Meanwhile, Jason Kulas, CFO of Santander Consumer USA, told analysts: “The growth in our originations in 2014 was driven by lease and prime, if you look at just the overall origination growth from 2013 versus 2014.”

Delinquencies stay flat

The move to securing a bigger share of the prime lending market is down to the fact that this represents the biggest area of opportunity, rather than a flight from the more problematic sub-prime segment. Indeed, so far there is little reason according to Experian to think this sector is proving particularly risky.

“The percentage of loans running at 30-day delinquencies is at 2.62% for the market as a whole, which suggests a pretty strong payment performance. And if we look at 60-day delinquencies, again the year-on-year change is very small – in fact, those are down one point at 0.72%. There’s no increase in delinquencies in the sub-prime range compared with last year,” Zabritski explained.

However, overall the Experian figures indicate there has been a rise of around 16% in the total amount at risk from 30-day delinquencies, which now stands at around $21 billion, with the largest share and the largest increase going to the finance companies. For 60-day delinquencies, the total at risk is also up by about the same amount, at around $5.4 billion, with the banks holding the biggest share.


Balances at risk


Delinquent balances

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In contrast to those who fear that these increases mean the auto lending market is veering out of control, Zabritski is firm in her view that the stable rate of delinquencies as a percentage of the total lending is a strong indicator that lenders have not taken their foot off the brake. Delinquency balances as an overall financial total are up purely because US car sales are also on the up.

Leasing remains dominant

“From the latest data, we see that leasing remains very dominant in the marketplace. It accounts for 14% of all transactions, both new and used, and has been following an upward trend over several years,” Zabritski said. “A quarter (25%) of all new auto purchases are via a lease, which means one in four new vehicles, and approximately 30% of all finance transactions are leases.”

Zabritski went on to point out: “While the most leases are for purchases of new cars (96%), leases for used car purchases are growing steadily, although they’ve not reached 4%. In 2009 we were seeing rates of 8% or more, but used car leases are nowhere near that now.”


8.77% 10.37% 10.45% 11.53%

13.58% 14.13%

20.65% 23.66% 23.13%

24.79%

28.84% 29.89%

16.84% 19.17% 19.02% 20.34%

24.16% 25.11%

0%

5%

10%

15%

20%

25%

30%

35%

Q4 2009 Q4 2010 Q4 2011 Q4 2012 Q4 2013 Q4 2014

Lease % of total

Lease % of new financing

Lease % of all new

Consumer leasing

Source: Experian Automotive

Leasing as percentage of total market and of new financing


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The average credit score for leasing dipped a little in the last quarter, down from 719 to 717, but 75% of leasing occurs in either the prime or super-prime segment. As Zabritski explains, monthly payments on leases are lower than loans, with the current average standing at $408, down from $420 a year ago.

The Experian figures also challenge the view that payments are coming down because the length of the lease is going up. Two thirds of leases are in the 25-months to 36-months category, with 35 months the overall average, while a quarter run for between 37 months and 48 months. The proportion of leases longer than that is extremely small.

Source: Experian Automotive 17 © 2013 Experian Information Solutions, Inc. All rights reserved. Experian Public.

Leasing and consumer credit

719 717

622 624

550

600

650

700

750

Q4 2013 Q4 2014

Average lease scores

NewUsed

6.58% 6.93% 16.65% 17.15%

48.90% 48.75%

27.50% 26.75%

0%10%20%30%40%50%60%70%80%90%

100%

Q4 2013 Q4 2014

New leasing by risk segment

Deep subprime Subprime NonprimePrime Super prime

New 96.3% Used

3.7%

Lease by vehicle type


Leasing by vehicle type and risk segment


$420

$408

$375

$385

$395

$405

$415

$425

$435

$445

Q4 2013 Q4 2014

Average monthly payment

8.04%

66.38%

24.82%

0.66% 0%

10%

20%

30%

40%

50%

60%

70%

13 - 24 25 - 36 37 - 48 49 - 60

Term distribution

Average new lease characteristics


Average term = 35 months


Avergage new lease characteristics

Deep sub-prime Sub-prime Non-prime

Prime Super-prime

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“Again if we look at new vehicle finance via loans, it is very much prime and super-prime. Deep sub-prime is a very small part of this market as well. Below-600 credit scores make up only around 10%, whereas in 2007 the proportion was 14.5%. Super-prime is three times the size of the higher risk tiers,” Zabritski said.

However, Experian’s data supports the claim that loan terms are lengthening. While the average term for loans has edged up by just one month, the largest growth category is for loans of between 73 months and 84 months, which are up by 29% for new cars and 17% for used cars.

With regards to loans for used cars, all of the growth in that market is coming from the prime sector and above; the sub-prime and deep sub-prime share is around 32%, compared to almost 40% pre-recession in 2007.

“Whenever there is an uptick in the number of loans to sub-prime and deep-subprime customers, there is the potential for a ‘sky is falling’ type of reaction,” Zabritski said. “The reality is we are looking at a remarkably stable automotive-loan market, in part because consumers are continuing to stay on top of their payments.”

“With that said, keeping an eye on consumer payment behavior and the lending community’s appetite for risk is important because these types of insights help the industry make better decisions that may affect loan terms or interest rates in the future,” she cautioned.

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Red light for regulations

Taken overall, the Experian data suggests it is very much “business as usual” as regards financing trends, but over the past year lenders have encountered a number of regulatory issues which potentially could bring the good news to a halt.

Lease accounting

In the background, there remains the longstanding issue of new rules for lease accounting. This represents the last ongoing main convergence project undertaken by the International Accounting Standards Board (IASB) and the US Financial Accounting Standards Board (FASB) in their joint attempt to harmonise US and international financial standards. Although some changes to lessor accounting are expected, lessee accounting is the area of biggest impact which will affect most companies and is likely to cause big changes to balance sheets.

Since the project got underway in 2008, the two regulators have published a discussion paper and two exposure drafts, changing their proposed model along the way. It is now clear that they are heading down differing accounting paths, although they continue to share one overriding goal, which is to bring leases on balance sheet. However, for some types of lease this will be carried out in two different ways, so P&L treatments will differ.

The IASB prefers a single method. Under this approach, when leases come on balance sheet there would be both a “right-of-use asset” and a lease liability initially measured at the net present value of the relevant lease payments. Two charges would then go through the income statement: amortisation of the right-of-use asset, and interest expense.

For its part, the FASB is proposing a dual method whereby most existing capital/finance leases would be treated in the same way as IASB proposes (Type A, with separate amortisation and interest). Most operating leases would be classed as Type B, with a single straight line lease expense in the income statement.

After eight years of discussions, reversals and differences of opinion, IASB is now due to publish the amended lease accounting standard by Q3 2015. Whilst the auto finance industry will welcome an end to the uncertainty, no one can be sure just what impact the changes will have.

Past misdemeanours

The US Department of Justice (DOJ) has spent the years since 2008 pursuing misdemeanour cases related to the height of the financial crisis in 2008, when complex securitization packages related to mortgages caused immense problems. Now officials have started to broaden inquiries, suggesting there may be parallels between home loan securitizations and auto loan securitizations.

Towards the end of last year, Las Vegas-based lender Consumer Portfolio Services disclosed it had received a subpoena from the DOJ requesting information in connection with a probe into “sub-prime automotive finance and related securitization activities.”

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The office of the Massachusetts Attorney has announced it is investigating Santander’s sub-prime auto lending business and has subpoenaed the company to produce documents related to borrowers’ credit histories, the interest rates they were charged, and how the loan risks were described to investors, using a similar approach to its investigations of sub-prime mortgage lending a few years ago.

Ally Financial, Credit Acceptance, Santander Consumer USA Holdings and General Motors’ auto financing arm all disclosed similar subpoenas during 2014. They were joined in early 2015 by Capital One and Credit Acceptance Corp who both notified the Securities and Exchange Commission (SEC) about subpoenas from local regulators and the DOJ, requesting information related to their sub-prime auto finance business.

One focus of the DOJ’s inquiries is believed to be whether there was appropriate disclosure made to investors about the quality of securities that are backed by auto loans. Data compiled by Bank of America Merrill Lynch suggests that auto loan-backed securities have continued to perform well, with the net loss rate standing at 4.51% in November 2014, below the lowest loss rates recorded pre-recession. However, as delinquencies on auto loans rise, so do concerns about performance going forward.

Discriminatory practices

Meanwhile, auto lenders large and small have also found themselves subject to close scrutiny from a range of regulators and US state legal departments over potentially discriminatory lending practices. The New York Department of Financial Services (NYDFS), for example, has slapped a $3 million penalty on local sub-prime auto lender Condor Capital and ordered the company to repay an estimated $8 million in restitution to borrowers, after which it will be closed down.

In this case, the first to be brought under the Dodd-Frank Act to enforce federal consumer protection laws, Condor Capital was found to have deceptively retained millions of dollars owed to vulnerable borrowers and overcharged them for interest. The NYDFS said Condor hid the fact that thousands of its customers had refundable positive credit balances, and also calculated interest charges based on a 360-day year but charged on a 365-day basis.

Race and ethnicity

For its part the DOJ has reported a settlement in its first-ever discrimination lawsuit involving “buy here, pay here” auto lending, as a result of which two dealerships based in North Carolina have agreed to set aside $225,000 to reimburse African-American clients intentionally targeted for predatory loans.

The lawsuit alleged that the two dealerships’ sales prices, unusually large down payments and interest rates, were disproportionately high compared to other sub-prime used-car dealers. Payments and interest rates were set without actually assessing customers’ credit histories or their ability to make payments. Additionally, the dealerships engaged in repossessions when customers were not in default.

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“It is not only illegal, but also fundamentally wrong, to target borrowers of color for predatory loans and exploit their need for a car to do essential tasks such as getting to work,” said acting assistant Attorney General Vanita Gupta of the Civil Rights Division. “I am pleased that these dealerships have agreed to reform problematic lending and servicing practices and adopt policies that promote responsible lending. I hope that other buy here, pay here dealerships will evaluate their practices in light of this settlement.”

And the problems are not confined to small, poorly run finance companies. JPMorgan Chase & Co revealed in an SEC filing in February 2015 that it is in discussions with the DOJ related to loans originating with auto dealers and financed by the bank that show “potential statistical disparities in markups charged to different races and ethnicities.”

Military personnel

In early January 2015 Santander Consumer USA reached a $9.35 million settlement with the DOJ over claims the company illegally repossessed cars from members of the military on active service. The deal, which relates to 1,112 automobile repossessions, is the largest ever levied under the Servicemembers Civil Relief Act (SCRA).

SCRA legislation protects serving personnel against certain civil proceedings that could affect their legal rights while they are in military service. It requires a court to review and approve any repossession if the service member took out the loan, and made a payment, before entering military service.

The DOJ lawsuit alleged that Santander initiated and completed 760 repossessions without the necessary court orders. The lender was required to pay to pay $10,000 each plus compensation for any lost equity (with interest) to service members who had taken out loans directly with Santander, and $5,000 to service members who had similar loans which the company had taken on from other financial institutions.

The repossessions involved took place between January 2008 and February 2013 and the matter came to light following a complaint lodged with the Army Legal Assistance Program. Army specialist Joshua Davis told lawyers that Santander illegally repossessed his car in the middle of the night while he was at basic training.

After the car was sold at auction, Santander sent Davis a bill to pay a deficiency balance of over $9,000 (including nearly $800 in repossession fees), reported his deficiency balance to the major credit bureaus, and sold the deficiency balance to a third-party debt buyer, according to the complaint.

“Those who answer this nation’s call to duty understandably have much on their minds while they are in military service,” said acting assistant attorney general Vanita Gupta of the DOJ’s civil rights division. “Whether their car will be seized and sold at auction should not be an additional worry. We will continue to vigorously pursue lenders who fail to take the simple steps necessary to determine, before repossessing a car, whether it is owned by a service member.”

Attorney General Vanita Gupta of the Civil Rights Division

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Consumer Financial Protection Bureau

The Consumer Financial Protection Bureau (CFPB) is the first US federal agency dedicated to protecting consumers in the marketplace for financial products and services, and was set up post the financial crisis under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.

The agency has already shown itself to be a prime mover in turning the spotlight on potential discrimination in auto lending. At the end of 2013 the CFPB ordered Ally Financial to pay $98 million to resolve claims that it charged approximately 235,000 minority car buyers higher interest rates than non-Hispanic white borrowers.

In this case the CFPB and the DOJ examined some 800,000 auto loans originated from April 2011 to March 2012. According to CFPB calculations, minority customers paid an additional $200 to $300 over the life of the average loan.

In a statement released at the time, Ally said it “does not engage in or condone violations of law or discriminatory practices,” and that based on its own analysis, Ally “does not believe that there is measurable discrimination by auto dealers.” In a further twist to the case, the CFPB said it was not accusing Ally of intentionally discriminating, noting that “Whether or not Ally consciously intended to discriminate makes no practical difference. In fact, we do not allege that Ally did so.”

Subsequently, Toyota Motor Credit and American Honda Finance Corp have revealed they have received letters from the CFPB and DOJ regarding auto lending originations and policies.

Auto loan scrutiny

Since the Ally case, the CFPB has indicated it intends to extend its area of focus and regulation beyond its original remit covering mortgages, student loans and US service personnel.

In 2015, for instance, the bureau fined Texas-based First Investors Financial Services Group $2.75 million after it concluded the auto finance company had knowingly provided inaccurate information to credit reporting agencies, potentially harming the credit ratings of tens of thousands of vulnerable consumers.

The company lends primarily to sub-prime borrowers, including those who have gone through bankruptcy, both directly and via auto dealers. A CFPB investigation found it had first identified flaws in the third-party computer system used to record customer details in 2011. While First Investors advised the unnamed software vendor about the problems, the company did not replace the system or take any steps to correct the inaccurate information it had supplied to Experian, TransUnion, and other credit rating agencies.

“First Investors showed careless disregard for its customers’ financial lives by knowingly distorting their credit profiles for years,” said CFPB director Richard Cordray. “Companies cannot pass the buck by blaming a computer system or vendor for their mistakes.”

CFPB director Richard Cordray

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The incorrect information included wrong payments and overdue amounts; distorted dates; inflated delinquencies, with one customer reported as delinquent 11 times in 24 months when the true figure was twice; and reporting vehicles as repossessed when in fact they had been voluntarily surrendered. Up to 12% of borrowers accounts were affected by credit reporting issues.

Stronger CFPB powers

In September 2014 the CFPB declared it wanted to make wider oversight of the auto loan market part of its official brief. It already supervises banks’ automotive lending divisions, and is now proposing it should also supervise non-bank auto finance companies, including the major captives.

“Many people depend on auto financing to pay for the car they need to get to work,” CFPB director Richard Cordray said. “Nonbank auto finance companies extend hundreds of billions of dollars in credit to American consumers, yet they have never been supervised at the federal level.”

The agency said it wants to define companies in this category as “larger market participants” if they enter into or otherwise acquire 10,000 or more loans, leases and and/or loan refinances per year. It also wants to define auto leasing as a financial product subject to regulation.

CFPB estimates suggest this change would extend its authority to around 90% of the nonbank auto finance market activity, and would affect 38 lenders that provided financing to 6.8 million consumers last year. It would also bring the bulk of all car purchases and leases into its scrutiny.

Cordray said: “This proposal is needed to level the playing field for banks and nonbanks in the auto lending market. We already supervise the auto lending practices of banks with more than $10 billion in assets. It should not matter whether you get a loan or lease from a company that has a banking charter versus one that does not – every auto lender should be following the law and be subject to the same level of oversight.”

The CFPB said it plans to scrutinize whether nonbank car-loan providers are discriminating against minorities, using deceptive tactics in marketing loans to consumers and following debt-collection laws. It has indicated it will also turn its attention to aspects of auto financing which are not mirrored with other financial products, such as the use of remote “starter interrupt” devices that lenders can use to disable cars if payments are even a few days late.

The proposals were subject to a 60-day consultation period in late 2014 which has only recently concluded. This invited input from stakeholders prior to the bureau taking its plan forward.

The American Financial Services Association (AFSA), which represents auto lenders among others, said the CFPB should oversee fewer companies. “What they’re doing is taking small- and medium-size players and forcing them to incur legal costs that are on par with multinational global companies,” said Bill Himpler, executive vice president of the trade group.

Part of the cost – and the worry – relates to the CFPB examination process, which involves rigorous on-site examinations that can last months and may result in enforcement actions and fines against lenders or refunds to consumers.

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Loan discrimination methodology

With the possible future direction of the CFPB’s work overseeing the auto loan industry still unclear, lenders’ representatives have fired the opening shots in a war over exactly how the industry is to be judged to be meeting consumer standards.

A coalition representing over 50 of the largest US auto finance sources is calling on the CFPB to address what it describes as “bias and error” in the method used to determine whether an indirect auto lender’s portfolio shows evidence of unintentional discrimination in the terms offered to specific groups of consumers.

In early 2015 the group led by the American Financial Services Association (AFSA) sent a letter to the CFPB claiming the bureau should revisit its enforcement approach in the light of an independent study carried out in November 2014 by consultancy Charles River Associates (CRA). This cast doubt on the reliability of many of the bureau’s findings, saying the methodology it used to analyze lending patterns overstated the impact on minorities.

By law, auto lenders are prohibited from inquiring into or considering a consumer’s race or ethnicity. In order to estimate the background of consumers for pricing comparison purposes, the CFPB uses a proxy that is based on a statistical analysis of the consumer’s last name and residence.

The CRA study, based on 8.2 million vehicle contracts originated in 2012 and 2013, suggested that the CFPB’s method overestimates minorities by as much as 41%. While the CFPB has conducted its own analysis of its methodology, which concluded that the margin of error was around 21%, it has not explained what, if any, action it has taken to address the discrepancy.

“The association requests that the bureau conduct a thorough review of the CRA study, provide a public response to its findings and recommendations, and correct any bias in its testing methodology, before pursuing further dealer mark-up discrimination claims through supervisory or enforcement action,” the letter stated.

As well as AFSA, other signatories included the American Bankers Association, Consumer Bankers Association, Financial Services Roundtable, and US Chamber of Commerce. They say they want assurance that the CFPB’s lending standards are “evidence-based, applied using analytically sound and transparent methods and predicated on accepted legal foundations.”

The National Automobile Dealers Association (NADA), the American International Automobile Dealers Association (AIADA), and the National Association of Minority Automobile Dealers (NAMAD) have also pledged their support to the coalition’s campaign, saying there are “legitimate, market-based reasons” for differences in interest rates.

“Discrimination in the market simply cannot be tolerated,” said NADA president Peter Welch. “However, in light of the rigorous peer-review that has cast significant doubt on the CFPB’s findings, the bureau should change course – or at least hit the pause button – and address these new concerns. We applaud the courage of these organizations for speaking up.” The CRA study, Fair Lending: Implications for the Indirect Auto Finance Market, was commissioned by AFSA. It recommended that the CFPB adopt portfolio level analysis of aggregated contracts sourced from dealers with different operating models, cost structures, pricing policies, locations,

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and competitive landscapes. It also said the model should be adjusted for legitimate business factors such as new, used, trade-in, options, insurance, and warranties.

Changing face of the consumer

While the CFPB is being challenged about how it can best demonstrate even-handed scrutiny of the auto loans market, the market itself is also facing tough new choices as a result of changing consumer buying patterns.

For some time now, it has become evident that many younger potential car purchasers are starting to query whether they want to buy a vehicle outright at all, particularly if they live in cities where other transport options are available and they want to cut down on the costs associated with car insurance, parking charges and other taxes.

Car sharing schemes, sometimes using an electric car fleet, are gaining in popularity as individuals turn away from the traditional model of car ownership, while new services such as Uber have made it easy to order a taxi at the touch of a smartphone screen.

This switch to car-usership requires that providers start to look at offering mobility services – that is managing a range of transport facilities which could include the family car, a vehicle used for company business and public transport. This move is already starting within the fleet management sector, as providers bundle together car leasing options, discounted air and rail travel and use-on-demand inner city vehicle hire.

Technology clearly has a role to play in this new approach, particularly as young consumers are used to searching online via smartphones for the availability of the nearest car share hub, for instance. They will be looking for a streamlined, one-stop-shop service with which to meet and finance all their transport needs.

Self-driving cars

And in the future, options could include self-driving, or autonomous, cars. Google and a number of other technology companies, along with Mercedes Benz and other car manufacturers, have made significant investments in this area. If successful, it will have significant implications for the auto industry, according to IHS Automotive. Its report, Autonomous Driving: Question is When, Not If, gives a global forecast for nearly 12 million in annual sales of self-driving cars in 2035, and suggests nearly all autos in use are likely to become self-driving on some level sometime after 2050.

“Google’s path goes through low-speed testing of self-driving cars in restricted areas beginning in 2015 and lasting three to five years,” said Egil Juliussen, the report’s co-author and director, research, infotainment and advanced driver assistance systems at IHS Automotive. “The next stage is small-scale deployment of low-speed L5 self-driving vehicles in campus-like environments and cities beginning in about 2020.”

The L5 category covers fully autonomous vehicles, that is those that have the ability to operate without a driver at all. Depending on their success, IHS Automotive anticipates low-speed L5 self-driving vehicles could enter volume deployment in 2025 with full deployment of L5 self-driving vehicles at any speed five years later. The research company says this approach will vastly expand the market for vehicles, offering Car-as-a-Service (CaaS)

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opportunities for business and individuals alike, which will call for radically different auto finance funding models.

Traditional vehicle manufacturers, on the other hand, are taking a slightly different tack in their development processes, working on technologies that help to augment driver behavior. This means adding incremental autonomous functions to those already available such as adaptive cruise control, lane keeping assist, advanced braking functionality. Traffic jam assist is next on the list, with autopilot features for highway driving and fully automated parking in the near future.

Millennials rev up car buying activity

Cars stuffed full of these kinds of new features are likely to find a warm welcome from the technology-savvy younger generation. Fears that younger people have lost their appetite for buying cars are unfounded, according to research from TransUnion, which suggests the millennial generation is the fastest-growing segment of auto loan consumers.

The credit reporting agency’s latest auto market report shows that the so-called “millennials”, that is consumers born in 1981 or after, represented 27% of total auto loan originations in 2014, up from 16% of total originations in 2009.

Millennials’ total outstanding auto balances have increased 23% in the past year, the highest of any age group. Average opening loan balances for this generation grew 4.1% year over year, up from $17,942 in 2013 to $18,678 in 2014.

“The growth in millennials’ auto loan originations dispels the common myth that millennials are not buying cars,” said Jason Laky, senior vice president and automotive business leader for TransUnion. “The growing average loan balances for millennials, combined with stable delinquency rates, indicate that we are still in the midst of a strong auto lending environment.”

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Conclusion

As credit ratings agencies, manufacturers, lenders and dealers all agree, the auto finance market stands at a crossroads.

Looking in one direction, data from TransUnion shows auto loan debt per borrower rose to $17,453 in Q4 2014, marking the 15th straight quarter of increases. Consumers are taking on more debt, and are starting to spread loans over longer periods, with the rise of the 84-month deal causing particular concern. There is also some evidence that lending to the sub-prime sector is on the rise. Put together, and it seems as if the auto lending industry is about to set off on the same road as it did in 2007-2008.

But from another point of view, the road ahead looks somewhat different from 2008. Cristian deRitis, a senior director at Moody’s Analytics, points out that while percentage growth is high, 84-month loans are still a relatively small slice of the business. Equifax credit reporting agency data suggests that for new- and used-vehicle loans combined, these very lengthy tie-ups accounted for about 3.25% of auto loans in October 2014 compared with about 2.25% in October 2008. While that signals a 43% increase, 84-month loans still represent less than 5% of the total lending market.

In addition, around 70% percent of 84-month loans are going to customers with credit scores higher than 680, which verge into prime territory. DeRitis also says that many such loans are made by credit unions, which tend to have very low delinquencies and close relationships with their members, further reducing risk.

Risk vs Opportunity

Auto and finance executives argue that strong used-car values, low interest rates and automakers’ greater discipline in managing production and incentives point to a more sustainable recovery in auto sales and lending, even as consumers increasingly opt for car loans that will take more than half a decade to repay. There are few, if any, signs that lenders are sacrificing quality for quantity.

“There is good discipline across the industry, and everyone is doing what it takes to manage their business appropriately, and it’s nothing like what we saw prerecession,” said Thomas King, senior director of the J.D. Power and Associates’ Power Information Network.

“There is, of course, risk for the long term,” King said of the growth in extended-term loans, “but that risk in magnitude is very small.”

These views are supported by data from TransUnion, which recorded 64.8 million auto loan accounts as of Q4 2014, up from 60.5 million in Q4 2013. Of the new auto trades, approximately one million were concentrated within the sub-prime tier, with little change from the same quarter of the previous year. Prime or higher tiers represented 64% of new auto trades, also flat relative to Q3 2013. The sub-prime delinquency rate increased only very slightly, from 5.72% in Q4 2013 to 5.92% in Q4 2014.

“Access to credit is expanding for American consumers, especially in the non-prime and sub-prime risk tiers” said Laky. “Lenders are apparently taking advantage of a strong economy and robust auto market to find profitable lending opportunities beyond the limits of traditionally low-risk credit tiers. And given the fact that delinquency levels remain near historic lows, that strategy appears well justified.”

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Even the OCC, which has been keen to highlight how weaker underwriting, longer loans and higher loan-to-value ratios could prove to be problematic, has admitted that there is no inevitability about this. While it is worried that the industry is shifting towards loans that focus on payment affordability rather than long-term sustainability, its report explicitly acknowledges that “the past, while providing us with good information, will not predict the future.”

Auto lending has changed significantly and rapidly over the last few years, and particularly since the dark days of the recession. Certainly the industry has to get its house in order, not least because of heightened regulatory oversight over the coming years, but the signs are that the future is looking positive.






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CHP Consulting US Auto Finance Market 2015 · and accounting of a wide variety of finance products; and combined with our unrivalled track record of delivering solutions on time and

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