Insights

On June 2, the Consumer Financial Protection Bureau published 1,300+ pages of proposed regulations for "Payday, Vehicle Title, and Certain High-Cost Installment Loans." The tome includes the usual proposed legal rule, a proposed Official Staff Commentary, and over a thousand pages of market analysis and elaboration of perceived market concerns for lenders that do not adequately consider the consumer's ability to pay before extending credit, relying instead on the ability to get paid either by debiting a bank account or threatening to repossess a car. The Bureau says that in about 20% of cases, vehicle title loans ultimately result in repossession.

Why should an auto dealer, or its indirect finance sources, care? Because, as proposed, the rule would apply to some indirect motor vehicle retail installment transactions, imposing significant, even crushing burdens on dealers and finance sources.

There are technical reasons and policy reasons why the subprime auto finance business should be paying attention.

Let's start with the technical reasons. The Bureau cast a very wide net in its definition of "covered loans." First, it is not limited to "loans" as credit lawyers would use that term. It includes all forms of "credit" that meet the other requirements. Of relevance here, credit scheduled to be repaid in more than 45 days secured by a vehicle and involving an all-in cost of credit of more than 36% per year is covered. There is an exception for the sort of "purchase-money" credit that car dealers typically offer, but the exception doesn't cover refinancing. And the exception is limited to transactions in which the amount financed includes solely the cost of a good, not services.

What about intangible ancillary products, such as a VSC, GAP, prepaid maintenance, credit insurance, or other F&I products? To the extent any product that is not "goods" is included in the amount financed, the exemption is lost. What is more, the price of credit insurance, GAP, and possibly other F&I products is treated as a finance charge for purposes of computing the trigger rate of 36%.

Here's a simple example: Assume a $10,000 amount financed that includes $1,500 for intangible F&I products. Assume a 30% simple interest rate for 24 months. Under the rule, the amount financed goes down to $8,500, and the finance charge increases by $1,500, increasing the yield on the transaction almost 9% per year ($1,500/$8,500/2 years). The 30% simple interest transaction just became a "covered loan." As the express interest rate on the transaction gets closer to 36%, the financing of even a small ancillary product cost increases the risk of creating a "covered loan."

On to policy concerns. The Bureau spent many pages in its exhaustive review of the allegedly abusive and unfair practices in the targeted markets focusing on the effects of lender "leverage" to extract payments. One effect is that it disincentivizes lenders from paying adequate attention to the consumer's ability to fit a new payment into a household budget and still meet major financial obligations and basic living expenses. The Bureau said that a lender that can threaten to take away a family's only means of transportation can force that family to prioritize an unaffordable title loan payment, at the expense of other debt payments and even food. The Bureau's remedy is to require a title or covered installment lender to project a budget for the length of the loan, using verified income, housing expenses, and debt expenses, plus estimates of living expenses, matching income events and payments every pay period (generally every two weeks). The Bureau highlighted that other markets, such as mortgage and credit card, are already subject to ability-to-repay regulatory requirements.

All of this raises the question: Can the same theories be applied to subprime auto? I would argue that the LTV in auto purchase finance will never support the asset-based underwriting that allegedly exists in vehicle title lending. At 100%+ LTV, it makes no sense to extend credit the consumer cannot afford to repay. But the Bureau would answer that it does, if the combination of high yield and the ability to "leverage" most consumers into prioritizing their car payment over other needs produces enough revenue to cover losses on deals that go bad, even a lot of bad deals.

Hopefully, the Bureau will add a factor to this calculus, a factor that is only marginally reviewed in the draft rule: the opportunity cost of loss of access to high-cost credit. That opportunity cost is hard to quantify in auto title and installment lending. In purchase-money auto finance, it is the inability to get to work or take the kids to the doctor because no financing is available for a car. Even if 20% of the customers fail and lose their cars under current underwriting, the 80% who succeed will have a huge opportunity loss if the Bureau bans the product or imposes unsupportable costs. Those 80% will not find cheaper credit elsewhere (or they would have already), and they will not find any credit if the Bureau declares the level of "inability to repay" imbedded in such a product to be unfair and abusive.

Stay tuned.

Richard P. Hackett is a partner in the Maine office of Hudson Cook, LLP. Rick can be reached at 207.541.9556 or by email at rhackett@hudco.com.