Prefer to defer: A cause for optimism among historically high auto loan extension rates
Auto lenders who have granted the fewest extensions during the COVID-19 pandemic have also seen the smallest declines in borrowers' payment rates. That could be good news for investors worried about a wave of defaults as extensions expire.
Steve McCarthy, CFA
June 16, 2020
As auto loan extension rates have grown steadily since the onset of the COVID-19 pandemic in early March, so too has concern among investors over the potential for a wave of defaults as those extensions’ terms expire. Indeed, by the end of April, Santander had extended nearly 30% of all loans by outstanding balance in their deep subprime shelf DRIVE, and World Omni had extended almost 35% of loans in their subprime shelf WOSAT (World Omni Select).
Not all public auto ABS issuers have been granting extensions to the same degree, however. While other subprime shelves have seen extension rates increase nearly tenfold since February, GM Financial’s AMCAR (AmeriCredit) shelf experienced a more modest doubling to slightly over 11% in April, well below the 25% of Santander's SDART shelf, the subprime shelf with the next lowest extension rate. Conversely, Ally Financial’s prime ALLYA shelf, which had extended only 0.66% of its loans in February, outpaced even AMCAR in April with an extension rate just shy of 20%.
Such dramatic increases in the number of payment deferments naturally raise the concern that they are simply delaying the inevitable and will soon give way to a similar spike in defaults once borrowers are required to resume making payments. However, payment rates among shelves that have granted fewer extensions than most, like AMCAR, provide some encouraging signs that this might not be the case.
Differing approaches to extensions
AMCAR and ALLYA highlight the challenges of using extension rates as a proxy for borrowers' current financial condition, as each servicer's policy on extensions can heavily influence the extension rates of its pools.
It is unlikely that ALLYA borrowers, with a weighted average FICO score of 738, would require extensions at a higher rate than that of subprime borrowers. Rather, we suspect ALLYA's extension rates are predominantly driven by the servicer's proactive approach to payment deferrals, which Ally Financial contrasted to what they characterized as the reactive offers seen across the rest of the industry. "Keep in mind with this [forbearance] population, we were very proactive, and you see across the industry a number of reactive offers. [...] We actually went out and emailed our customers and offered them the opportunity to have some more payment flexibility," Ally Financial's CFO Jenn LaClair said in an April 20 earnings call.
In contrast, an answer to an FAQ asking "[a]m I eligible for a payment extension on my retail (APR or loan) contract" that appeared on GM Financial's COVID-19 assistance page from late March until sometime in late May warned about the increased interest costs that normally accrue from payment extensions. Instead, GM Financial suggested that a late payment may be a better option for many borrowers. "However, [a payment deferment] is not the only way GM Financial can help customers experiencing financial hardship and for many, other steps that can be taken are better. While very effective at addressing immediate payment concerns, deferments often result in greater increased overall interest costs as the daily accrual of interest continues to occur during the deferred period," the answer stated, going on to warn that the accrued interest "will likely result in a higher final payment due at the end of your contract."
Those higher final payments are not insignificant, either. A research report published by Kroll Bond Rating Agency found that just a one month extension early in the term for a 72-month loan with a 20% APR will result in the equivalent of an extra two payments being due at maturity. Of course, subprime borrowers like AMCAR's, with a weighted average APR of 13% will accrue interest at a much faster rate than those of ALLYA, with a weighted average APR of 6.5% (though we note that GM Financial's prime shelf GMCAR, which shares the same COVID-19 assistance page with AMCAR, also granted fewer extensions than most).
Payment rates
Since many lenders have been generous with deferments since March, and little motivation exists for borrowers to refuse an offer that would provide additional flexibility in a time of such great uncertainty, it's hard to estimate the proportion of borrowers that would have been able to continue making payments had deferment not been an option. Recently, some banking executives have expressed skepticism that all borrowers who have taken advantage of extensions truly needed to do so in order to stay current. AMCAR and a few other issuers' payment rates seem to support that belief.
Assuming borrowers are taking advantage of extensions only to avoid an imminent missed payment, we would expect to see payment rates decline proportionally across shelves of similar credit profiles, regardless of any one issuer's policies around extension rates; whether the borrower misses a payment and goes delinquent or defers a payment as a result of a extension will have the same effect on the pool's payment rate.
As of April, however, this does not appear to be the case. Instead, the shelves that have issued the fewest extensions (as a proportion of their outstanding balance) are also the shelves that have seen the smallest decreases in payment rates, suggesting that at least so far, borrowers may be taking advantage of extensions to maintain financial flexibility rather than as a last resort to avoid a missed payment. AMCAR, for example, stands out as exhibiting the lowest drop-off in payment rates between April 2019 and April 2020 despite being a subprime shelf; its April 2020 payment rate was still 98% of its April 2019 payment rate.
Note: we consider a borrower to have made a payment during a given month if the amount collected in the month is greater than 90% of the scheduled monthly payment.
AMCAR's year-over-year payment rates also behave counterintuitively when bucketed by APR. Taking into account the credit characteristics that usually accompany higher-APR loans (e.g. lower FICO scores, higher PTIs, etc.), we'd expect loans in these buckets to be more frequently impacted by the current crisis. While this assumption plays out for most shelves, higher-APR buckets for AMCAR have actually experienced a smaller decrease in payment rates than lower-APR buckets; in fact, a few of AMCAR's higher-APR buckets actually performed better this year than last. AMCAR also outperformed an aggregate of all other public shelves at all APR buckets across the 5% to 18% range.
Caveats: Serious delinquencies and other macroeconomic considerations
While most borrowers who were current on their loans going into the crisis have managed to remain so even without the help of extensions so far, borrowers who have already fallen behind are struggling to catch up again. Despite staying steady or slightly declining across most other shelves, 60+ day delinquencies have climbed for all shelves that ranked among those with the lowest extension rates. AMCAR, for example, saw a 0.36% increase in its 60+ delinquency rate between February and April, from 2.46% to 2.82%.
While roughly the same rate of seriously delinquent borrowers as this time last year have been able to resist falling further behind on their payments, borrowers are finding it much more difficult to catch up on previously missed payments than they did last year. For example, the rate of seriously delinquent AMCAR borrowers who were able to make at least one payment shrank only 9%, but the rate of those who were able to make at least two payments (thus catching up by at least one month) shrank more than 32%.
We can only speculate as to why borrowers are able to resist falling further behind on payments at roughly the same rate as they were pre-pandemic, but are having a much harder time catching up. One possibility is that while borrowers adversely impacted by the pandemic are able to rely on unemployment benefits to tide them over, the rout in the jobs market has made it increasingly difficult to generate additional income to catch up on payments through means such as a second job. Contractions in the consumer credit market may also be contributing, reducing the possibility of opening new lines of credit such as personal loans to be used to pay off delinquent auto loan balances.
Additional macroeconomic considerations also make clear there is no guarantee that payment rates will remain as relatively unaffected as they have been so far. We do not know the extent to which borrowers' continued payments have relied on the federal government's $1,200 economic impact payment, which many believe will not be repeated. Further, a federal supplement of $600/week on top of unemployment benefits Americans are already receiving from their state unemployment programs is scheduled to end in July, and many of the eviction moratoriums enacted in some states will expire over the summer months. Finally, research performed by a trio of University of Chicago economists and published by the National Bureau of Economic Research found that 68% of those currently receiving unemployment benefits are earning more income while on unemployment than they did from their prior employment; thus, borrowers may be facing tighter budgets once they return to work and become ineligible for continued unemployment benefits.
Indicators for optimism
So far, steady payment rates in the face of relatively lower extension rates provide a reason for optimism that a preference for financial flexibility rather than an inability to pay is driving the recent historic growth in auto loan extension rates. However, with many workers rolling off unemployment benefits as they return to work, and government benefit programs slated to end in the coming months, it will be important to continue monitoring both payment and extension rates as borrowers' wherewithal is tested.
Lastly, even as the immediate impacts of the COVID-19 pandemic subside in the coming months, the effects of the massive number of extensions that have been granted to date will not be felt until the loans mature, at which point the additional interest that accrued during the extension period becomes due. Historically, borrowers have been able to satisfy these lump sums by rolling them into higher LTV loans on their next automobile purchase; whether lenders' appetites for such arrangements will remain in the coming years will not be seen for some time.
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