Why LHPH in Today’s Market? Pandemic Upends Credit Scorecards and Drives Subprime Auto Lower

Eyo Toe | October 20, 2020

 Why LHPH in Today’s Market? Pandemic Upends Credit Scorecards and Drives Subprime Auto Lower

In a recent article published by the Wall Street Journal on October 18, 2020, the Journal identified another unique attribute of this pandemic-driven recession, FICO scores have improved while unemployment has spiked.  “The average FICO credit score stood at 711 in July, up from 708 in April and 706 a year earlier, according to Fair Isaac Corp.”  Obviously, this is a function of the massive financial stimulus and assistance provided by the U.S. government to stem the damage of the COVID pandemic.

However, there are still millions of Americans out of work and much of the stimulus has expired or will soon.  “First the macro stress occurs, and then it takes a few months for the strain to show up in people’s credit reports,” said Ethan Dornhelm, vice president of scores and predictive analytics at FICO, “Deferment programs and government stimulus are having a further effect of pushing out that stress for many people.”  While more assistance may be on the way, it is likely many of the jobs lost will not return and unemployment will remain stubbornly elevated for much longer than anyone had hoped.

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As the WSJ notes, “The disconnect has scrambled lenders’ underwriting models and sent them in search of new ways to evaluate applicants’ creditworthiness.”  This impact can also be seen in the Experian State of the Automotive Finance Market Q2 2020 report.  Deep Subprime loans accounted for only 4.35% of all used loans in Q2, a record low in the automotive market and significantly below even Great Recession levels (see chart below).

Why LHPH in Today’s Market? Pandemic Upends Credit Scorecards and Drives Subprime Auto Lower

While lenders continue search for alternative bureau data to supplement their traditional scorecards during this unprecedented time, there remains the likelihood that the worst is yet to come for consumer credit.  “One big fear is that consumers’ credit quality could begin to sour… ‘We’re afraid that in a couple months there could be real damage to credit reports,’ said Francis Creighton, chief executive of the Consumer Data Industry Associations, which represents credit-reporting firms.”

The result of these factors in the auto finance industry will be a prolonged period of reduced subprime lending by traditional banks and finance companies.  Lenders will not jump right back into the subprime market with so much uncertainty over their scoring models, the time necessary to vet and back-test alternative bureau data as supplements, and the likelihood of deteriorating creditworthiness over the foreseeable future.

For dealers, this means a large percentage of the customers that walk on their lot will be unable to secure financing for a new or used vehicle.  These dealers will be forced to walk many of these customers that just a year ago would have been a deal, or if they can get the customer approved, pay much higher discount fees to hang the deal.

One solution to this challenge for well positioned dealers is to rollout their own Lease-Here, Pay-Here platform.  By implementing their own program, dealers can keep these customers, put them over the curb in a reliable vehicle, and enjoy additional profitability from retaining the financing on these customers.  The reduction in competition in the subprime space means LHPH dealers now have access to more customers, and customers of higher quality, who are still unable to get financing from a traditional source.  In addition, there are a number of tax benefits associated with the depreciation accrued from their lease portfolio that can help offset the income of their retail operation.

To learn more about all the benefits of Lease-Here, Pay-Here, check out our blog or download our free e-book here:

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