If subprime auto delinquencies continue to rise and the risks continue to grow, it will be cold comfort to those who saw it coming, if they haven't taken protective measures. There's no glory being on the wrong side of right.
From this perspective, there is real value in any service that has the potential to help participants see ahead of the curve and mitigate risks. With this in mind, we spoke to Justin Bannister, Director of Centralized Operations, and Oscar Lopez, Specialty Products Manager, of CAR Financial Services, a subprime auto finance company with over 25 years of experience providing customized backup and successor servicing.
In the first part of our two-part interview, we discuss risks in subprime auto and how backup servicing could potentially support quality portfolio performance while providing risk mitigation commonly associated with this sector of the industry.
Industry Professional's Advice on the Benefits of Having Backup Servicing in Place
What potential issues do you see in subprime auto lending and ABS?
Subprime has enjoyed a great deal of growth over the last 10 years of economic recovery. There have been many new lenders who came into this space as overall lending costs have made the space look very attractive. All of this new participation in the space has created well documented trends that could prove troubling. Longer term loans, increased loan to value ratios, lower down payments, higher amounts financed and older model units with higher miles used in inventory to limit costs have all led to current delinquency rates that are comparable to levels during the last financial crises, all during a robust economy. The caution here is that many lenders took off with high growth rates on inception and are now seeing the real performance, as growth has slowed and vintage bad debt rates show the collectability of the portfolio.
How would a backup servicer mitigate losses from those issues?
A backup servicer should be active, not passive, and play a value-added role for lenders.
For example, an experienced backup servicer would be able to help a lender identify or verify disturbing trends in portfolio performance so that they may be able to influence underwriting with the borrower in a way that positively impacts performance going forward, perhaps helping to avoid a complete default in the first place. In addition, having a backup servicer in place provides a real mechanism to keep positive proactive communication between the lender and borrower. A backup servicer that has been in place from the beginning can help the lender and borrower market receivables by validating performance data to third party potential buyers.
What do you think are the keys to success for a backup servicer, specifically in subprime auto?
One of the most important elements is to have a backup servicer in place at the onset of a lending agreement. Given industry default rates in the subprime sector, it is always prudent to have a backup servicer in place even if you believe your investment or your lending leverage appears to be at a conservative equity level. A common misconception is that you can just jump in at any time and implement a backup servicer when borrower issues have come to the forefront. If a borrower/lender relationship has become contentious, acquiring the data necessary to transition the accounts quickly and successfully can drag out. There is a big difference in the general data some lenders look at monthly to monitor accounts and the account detail necessary to transition collections effectively. The time lost in gathering data once a portfolio and lending relationship have become contentious will only lead to further degradation of the performing accounts.
Given the importance of backup servicing, how would a lender get started evaluating their particular needs?
As a positive first step in validation of not only the portfolio's value but of the overall risk currently in the existing portfolio, a lender could seek a portfolio evaluation from an experienced backup servicer. CAR Financial Services will provide free portfolio evaluations under no additional obligation, which can be of great benefit to the lender in determining whether engaging a backup servicer is prudent today.
While the future of subprime auto may be up for debate, prudent protective practices can provide a more certain result. Proactive engagement of a backup servicer could avoid losses that would otherwise occur if borrowers begin to default and the portfolio needs to be transitioned with no plan in place.
In part two of our interview with CAR, we'll explore what to look for in a backup servicing relationship and tips for a successful engagement.
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