Enter winter 2021– if the forecasted 2.55 million repossessions this year play out, and car values continue their downward trend, recoveries will be shaky at best. New originations made in 2020 despite significant credit blind spots will likely compound the problem. Strategies to pull down repossession volume should be in the works now.
Mid-summer speculations of a fast economic recovery have faded, replaced by warning flags for a challenging 2021. Many industry reports are highlighting the need for lenders to reign in credit policies to protect limited capital available for new origination.
Market distortions have turned the FICO score on its head
A lender’s reliance on FICO to determine creditworthiness may be compromised. Government stimulus payments caused a temporary income upsurge, and lender payment holiday programs didn’t cause scores to drop. With these distortions, a credit policy almost needs to be forensic to generate profit.
The 2020 NAF Non-Prime Auto Financing Survey reported a 32-point increase in Median Origination FICO scores for non-prime borrowers from May 2019 to May 2020, with next to no change in the March and April year over year volumes. Ehan Dornhelm of FICO provided a word of caution: “The FICO score shouldn’t be thought of as a leading indicator or as a predictor of where the economy is headed…[in fact] there’s typically a ‘bit of a lag’ between when a major macroeconomic event occurs…and when the average FICO score is going to reflect that,” he says.
If the lag is anything like during the Great Recession when the average FICO score hit its lowest point a full year after Lehman Brothers collapsed, there should be cause for concern. Oddly, alternative loss mitigation strategies are rarely discussed even as FICO-dependent, risk-based priced origination may require intentional and robust relief solutions, post-origination.
Short-term extensions → spin the dialer → repossess. It won’t be enough.
If I said “housing prices are at their peak, it’s time to start foreclosing,” there would be a collective gasp. Yet, when vehicle values hit a peak this summer, lenders looked to a tested strategy to secure recovery dollars: repossession. Even with 12 straight weeks of declining car values, recovery managers are expected to push vehicles into bidding lanes as repo moratoriums are lifted because the future is uncertain. What happens when supply drives values below FMV? Implementing robust loss mitigation options now can prepare lenders for a range of economic scenarios.
Auto lenders can take a page from the mortgage loss mitigation book which looks more like this:
Short-term forbearance → spin the dialer → restructure → short sale → foreclosure
Prior to 2008, loan restructuring and short sales for mortgage obligations were nearly non-existent, similar to the auto industry today. As the crisis deepened, government mandates emerged requiring lenders to exhaust all possible relief options available prior to starting foreclosure proceedings. What was a fragile and chaotic start ended in progressive strategies to preserve homeownership through loan modifications for those that could afford it. Workout options like short sale and deed in lieu of foreclosure for those who could no longer manage the obligation offered a path to a graceful exit.
This significantly mitigated credit loss in a market where most homes were underwater (not unlike vehicles today), and helped lenders avoid unnecessary consumer harm that would have impacted the speed of recovery.
Auto lenders can take these steps, now
There is no loss mitigation playbook mandated by the government in the auto sector. Auto lenders need to decide soon if expanded hardship relief will be part of their 2021 strategy. By introducing loan restructuring, auto lenders can help borrowers who have a commitment to repay, stave off financial ruin, and continue repayment. Additionally, if lenders offer short pay off or voluntary surrender options, borrowers can amicably exit if their willingness to repay is not supported by the ability to repay. There are a number of options between a short-term extension and repossession that can lead to increased recoveries and avoid unnecessary consumer harm.
Here’s where to start:
Culture. Determine your company’s appetite for expanding loss mitigation strategies, consumer protection and customer experience.
Policy. Similar to the introduction of new origination products, establish affordability thresholds, set a floor for term changes, and determine eligibility criteria for inclusions and exclusions.
Education. Create clear and conspicuous processes, communications and disclosures. Consider the customer impact at every point of the journey.
Return analysis. Set parameters for expected return on modifications and repossession. As market conditions and car values fluctuate, program parameters and relief options can expand and contract to fit the market.
Tracking. Set a plan to track post-mortem performance rates and leverage loss mitigation data to strengthen origination policies.
Technology. Automate the offering of expanded loss mitigation and data insights to keep you on track.
Leverage self-service technology for quick pivots and to project loss savings
Self-service technology solutions are opening up communication channels with borrowers. Lenders can automate and offer mortgage-style loss mitigation solutions and dig into borrower-level hardships to determine whether to extend, recast, restructure or repossess (depending on market conditions) to maximize recovery. As average loan balances, payments and loan-to-value ratios increase, and rates adjust, automation of these new solutions is critical to stay nimble and react quickly.
While 2021 will be unpredictable, we can be certain that more help will be needed, and the challenges facing the industry will be measured in years, not months. TransUnion’s Q3 2020 Industry Insights Report noted that approximately 3.8MM auto accounts were in some form of relief program, and Black Book’s most recent Market Insights reported approximately 11.75 percent of sub-prime auto accounts were in hardship.
‘Wait and see’ is not a strategy
Bruce Curry, Vice President for Collections and Recovery at FICO, didn’t mince words when talking about the harsh reality we should expect in 2021. He noted that “the number of customers deemed vulnerable will go through the roof,” that lenders will move “from an empathic view to a toxic assets view” and that “banks can’t recruit enough people to service.”
I agree with his view that lessons of the past are not being heeded and that it will be too easy to blame losses on the economic state rather than adopting a plan to mitigate losses and impacts on consumers. He asks, “Will it be a collective industry approach to solve a debt crisis? Or a scramble for the little money that’s there?”
It’s the exact call to action the auto industry needs to contain the potential fallout of 2021. Taking intentional and strategic steps forward to distinguish ability and willingness to repay from inevitable losses is key. Self-service technology, automation of relief options, and the resulting analytics and insights can help lenders better prepare for continued market volatility.