Jerome Powell, chairman of the U.S. Federal Reserve, speaks during an Economic Club of Washington discussion in Washington, D.C., on Thursday, Jan. 10, 2019. The labor market is very strong and the Federal Reserve sees continued momentum in the data, Powell said. Photographer: Al Drago/Bloomberg

Federal Reserve Chairman Jerome Powell said the U.S. central bank can be patient before adjusting interest rates again as it waits to see how global risks impact the domestic economy.

“We’re in a place where we can be patient and flexible and wait and see what does evolve, and I think for the meantime we’re waiting and watching,” Powell said in a question-and-answer session Thursday at the Economic Club of Washington, D.C. “You should anticipate that we’re going to be patient and watching, and waiting and seeing.”

U.S. stocks turned lower after Powell said the central bank is sticking with its process of shrinking its balance sheet to a more normal level, which removes stimulus put into place to revive the economy following the financial crisis and recession a decade ago.

The balance sheet “will be substantially smaller than it is now,” though bigger than it was before the crisis, Powell said. He said he didn’t know the exact level.

What Our Economists Say

“Chairman Powell chose to make no news at his latest interview. He simply reiterated the message from the latest FOMC minutes that policy makers regard the economic outlook as solid, despite intensifying downside risks. The recent data dependency mantra simply implies the Fed is taking a wait-and-see approach to be able to assess whether “tail risks” will weigh on economic performance.”– Yelena Shulyatyeva, Bloomberg Economics

Read More: Fed Minutes Reveal Caution on Rates Missing From Statement

U.S. central bankers are refining their message after the hawkish tone of their Dec. 19 statement and forecasts for further rate hikes in 2019 roiled financial markets. The Fed’s communications — and a Bloomberg News report that President Donald Trump had discussed firing Powell — helping bring on the worst December for stocks since the Great Depression.

Since the meeting, Fed officials have indicated they’re less inclined to keep raising than their statement and projections for two hikes in 2019 had suggested.

Powell said last week that he’s “listening sensitively to the message that markets are sending” about downside risks. Minutes of the December meeting released on Wednesday showed that many officials felt the central bank “could afford to be patient about further policy firming,” indicating the Fed could place interest rates on hold through March or longer as it waits for clarity on risks to global growth that could affect the U.S. economy.

Flexible Approach

The more flexible approach, apparent in the minutes and in recent speeches, has supported stock prices. Bloomberg’s financial conditions index has retraced much of its December tightening.

On Thursday, Powell said he hasn’t seen anything to indicate that the risk of a recession is elevated. The partial government shutdown is unlikely to leave a mark on the economy in the short term, though the Fed will have a less clear picture of growth without data from the Commerce Department, which releases figures including retail sales and gross domestic product.

At the same time, Powell acknowledged that financial markets are expressing concern about risks. The principal worry is global growth, he said in questioning by David Rubenstein, the co-founder of private-equity firm Carlyle Group, where Powell was previously a partner. Rubenstein also hosts an interview show on Bloomberg Television.

Powell also said he didn’t think it would be appropriate to reject an invitation to meet with Trump, but he hasn’t yet received such an invitation. Fed chairs have met with presidents in the past, he added.

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Evans: Fed Can Easily Look at Data for 6 Months Before Rate Hike  Kashkari: Labor Slack, Global Data Allow Fed to ‘Take It Easy’  Fed’s Bullard Fears Being on the ‘Precipice of a Policy Mistake’  Powell Says No Trump Invite Yet and He Would Meet With President

Fed policy makers projected above-trend economic growth for this year in their December forecasts, and they expect the unemployment rate to fall further. Those forecasts appear supported by a robust December labor-market report, which showed the economy added 312,000 non-farm jobs, the most in 10 months. The unemployment rate stands at 3.9 percent and central bankers expect it to average 3.5 percent in the final three months of this year.

Even so, U.S. central bankers face a challenging year that’s complicating their communication. Financial markets are incorporating a variety of risks to the outlook, ranging from slowing global growth to the potential for a protracted trade war with China.

— Craig Torres and Christopher Condon (Bloomberg)

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As lenders increasingly look to fintech companies to facilitate loan origination, one analyst warned these partnerships can be a double-edged sword.

“If [lenders] are leveraging some fintech platform that claims to have built the better mousetrap in terms of their underwriting platform but haven’t been around through credit cycles and haven’t proven that out, to me, that creates additional risk,” Fitch Ratings Agency’s Senior Director of Financial Institutions, Michael Taiano, told AFN.

Taiano was referring to loan originators with limited performance histories.

“We don’t want to get into a situation like we had in the mortgage space in 2008 and 2009 where you had a lot of these originate-and-sell models,” Taiano said, “because ultimately those originators are not holding onto the credit risk.” When banks and lenders partner with fintech companies, “the ultimate owner of the credit and the originator are kind of disconnected,” Taiano said.

If this is the case, the originator may be more willing to take on riskier borrowers, he said. While these fintechs may create “an avenue for banks and such to grow, at the end of the day it’s not their own platform that’s been proven over time,” he added.

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Photographer: Angel Navarrete/Bloomberg

Santander Consumer USA‘s first asset-backed securitization of the year is on track for lower losses relative to prior pools, despite higher loan-to-value ratios and a smaller percentage of new vehicles in the pool, according to Moody’s Investors Service.

Moody’s assigned a 24% cumulative net loss expectation to the $1.2 billion transaction, which is slated to close Jan. 23. By comparison, Santander’s last securitization of 2018 had a 25% cumulative net loss expectation.

The lower loss expectations are driven by stronger obligor credit quality, Moddy’s said. The weighted average Fico of loans in the pool was 584, compared with 577 in the lender’s previos securitization. Seasoning for loans in the transaction was four months, compared with two months in Santander’s previous deal.

Meanwhile, the average LTV for loans in the securitization pool was 110%, up from 108% in the October securitization. The new-used ratio was 39%-61%, compared with 42%-58% previously.

Santander issued approximately $7.2 billion over five deals in 2018, while its auto loan portfolio totaled $26 billion as of September 30, 2018, according to Moody’s.

A portion of the collateral pool consists of loans originated by Santander’s Chrysler Capital assets, which Moody’s highlights as a risk factor due to Fiat Chrysler Auto’s plans to form its own captive finance arm. Moody’s says if captive plans follow through Santander’s ABS deal would be, “moderately negatively affected by this development,” the presale report notes.

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Subprime lender Exeter Finance Corp. filed for an initial public offering to gain a larger marketshare in the “fragmented” auto finance industry, the company said in a Jan. 8 regulatory filing with the U.S. Securities and Exchange Commission.

Blackstone-backed Exeter expects to raise $100 million in the IPO, the filing notes, though the timing of the offering is unclear. The stock would trade on the New York Stock Exchange under the ticker XTF.

Exeter had a $4 billion portfolio with an average Fico score of 567, as of Sept. 30, 2018, according to the S-1, and 78% of loans were originated on used cars. Exeter works with 10,500 dealers across the nation.

One analyst told Auto Finance News that for a company of Irving, Texas-based Exeter’s size, it would be better to sell than to go public. Blackstone has reached out to three potential buyers, according to Reuters.

Exeter increased net income to $57.4 million in the third quarter of 2018, compared with $12.1 million in the prior-year period. The lender had $3.5 billion in debt as of Sept. 30, 2018.

The S-1 filing highlights Exeter’s strategic partnerships, which accounted for 38% of originations for the nine months ended Sept. 30, 2018, compared with 28% through yearend 2017. Consumer credit applications turned down by captives, banks, and independent dealer groups are funneled to Exeter for underwriting. Exeter noted in the S-1 that it is looking to ink similar agreements with manufacturers:

“We seek to establish OEM partnerships that may offer select participating lenders general market incentives (a subsidy provided by the OEM to the lender which is passed through to the consumer or the sourcing dealer) or may receive direct pay subvention on select vehicle makes and models. We believe subvention generally increases retail installment contract capture rates, as other lenders are not provided the same credit subsidy.”

For funding, Exeter relies on the ABS market and warehouse facilities. Exeter has a $1.75 billion warehouse facility that matures in June 2021, and a $1.4 billion facility that matures in May 2020. Since 2012, Exeter issued 19 ABS transactions totaling $8.6 billion.

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The auto finance market is rapidly evolving as consumer preferences change, marketing technology evolves, and smartphones threaten traditional sales strategies.

Auto Finance News has developed a comprehensive program to address these trends and more at the Auto Finance Sales & Marketing Summit, which will be held at the Omni San Diego on May 13.

Produced by Auto Finance News and Royal Media, the Auto Finance Sales & Marketing Summit will consist of one-on-one chats with top executives, as well as presentations and panel discussions with industry thought leaders. The full Auto Finance Sales & Marketing Summit agenda can be found here.

Participants will gain insights into new ways of measuring sales rep performance, developing a direct lending marketing strategy, technologies to improve marketing efficiencies, and more.

Additional topics for discussion will include managing the modern “martech” landscape; how the ‘Amazon effect’ changes customer service strategies; the latest on marketing analytics to boost sales and efficiency, and more.

To learn more — or to register — for this year’s event, visit the Auto Finance Accelerate homepage here.

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Capital One Auto Finance filed a lawsuit against Cape Girardeau, Mo.-based Coad Toyota claiming $619,690 in damages for allegedly misrepresenting facts about vehicles sold and falsifying down payments and sales tax in 34 instances, according to court documents filed Dec. 21, 2018.

In one example cited in the lawsuit, the dealership allegedly supplied information to the lender indicating that the borrowers made a cash down payment when, in fact, they did not. The dealership further declared that the vehicle sale included $5,000 in sales tax. However, the Missouri Department of Revenue estimates that the sales tax should have been $1,365.96, according to the court filing.

Of the 34 instances outlined in the lawsuit, at least seven were related to “power booking,” or a dealership’s practice of falsifying the features and options on the vehicle to inflate its value. “Power booking” manipulates the risk analysis that a lender performs to decide whether to purchase receivables and to induce the lender into buying the receivables, according to the suit.

Capital One said it “reasonably relied” on Coad Toyota’s statements because they were not “exaggerated or beyond belief” and because the dealership made the statements in the regular course of business and dealings with the lender, according to the lawsuit. However, Capital one was induced into purchasing receivables it otherwise would not have purchased or would have purchased under different terms, the lawsuit claims.

A timeline for the case was not provided in court documents. Capital One did not immediately respond to requests for comment.

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GM Financial has kicked off 2019 auto asset-backed securitization activity with a $1.25 billion deal issued last week, according to presale reports.

Although analysts anticipate macroeconomic headwinds, such as interest rate stresses, to hit the industry this year, Fitch Ratings Agency said in its presale report that losses in GM Financial’s 2016 and 2017 managed portfolio and securitizations “are low and have been improving.”

GM Financial began originating prime loans in 2014, so empirical data on the performance of these loans is thin, Fitch said. In its rating, Fitch used data from comparable origination platforms to supplement GMF data. As a result, it derived a forward-looking credit loss expectation of 1.25%, down from 1.40% to 1.50% from its 2018 ABS transactions. The deal is the eighth by the captive finance arm of General Motors since 2010.

The transaction is backed by 45,890 loans, down from 46,634 loans in GMF’s first ABS deal of 2018. The average principal balance was essentially flat at $28,731, according to Fitch.

Loans in the transaction have weighted average Fico scores of 778, compared with scores in the 760 to 770 range in the past two years, and new vehicles account for 87.7% of the pool.

GM Financial issued approximately $5.4 billion in four separate securitizations last year, the most recent in October 2018 at $1.3 billion.

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The January 2019 issue of Auto Finance News is now available.

From the January issue: 2018 was a strong year for auto finance as delinquency rates dropped, the economy grew, and consumer demand remained high.

However, the new year finds lenders and analysts bracing for an economic slowdown. But that’s not the only worry. New-car purchases are lagging, according to Manheim’s November data, which has new-vehicle sales down 0.7% year over year. On top of that, rising tariffs and higher interest rates could stymie growth in 2019.

“In some ways, it’s a house of cards,” said Jessica Caldwell, executive director of industry analysis for Edmunds. “As access to cheap and easy credit grows scarce, many buyers may be forced into the used market, or even be priced out of a purchase completely. If, for some reason, the economy suddenly collapses or if tariffs are enacted and raise prices even more dramatically, things could take a turn very quickly.”

Lenders that will thrive in the new year will be the ones that are prepared.

“The worst position [a lender] could be in is being surprised, not having a plan, and trying to improvise when confronted with an issue,” Marcelo Brutti, chief risk officer at Hyundai Capital America, told Auto Finance News. “Our job is to monitor all of [the risk factors] and make sure that those we can manage have discipline. We have to understand the potential economic cycle and be ready for it to protect the captive, the OEMs, dealers, and the reputation of the brand.”

Industrywide, lenders are starting to bump up subprime volume, extend loan terms, and increase technology investments, particularly in data and analytics that allow lenders to better track performance.

The Subprime Sector

Following a pullback from the subprime sector in the past few years, originations to credit-challenged borrowers are expected to account for 16.5% of loans in 2019, compared with 15.1% in 2018, according to TransUnion’s 2019 consumer credit forecast. Positive economic trends and opportunities to boost profits are spurring growth in subprime, Brian Landau, senior vice president and auto line of business leader at TransUnion, told AFN. Specifically, lenders feel more confident going back to subprime because of macroeconomic performance like stabilizing delinquencies and a low unemployment rate, he said. The 60-day delinquency rate is anticipated to stay flat at 1.44% through 2019. “The auto market is starting to recalibrate itself after the pullbacks in [2016 and 2017],” Landau said. However, the competition for subprime loans will likely increase. “If [one lender] is going to tap into subprime consumers, so are other lenders,” Landau said. “The profit is in subprime, and lenders have to make money.”

Loan Extensions

With affordability in question and subprime originations expected to climb, it’s important for lenders to come up with strategies to avoid delinquencies, David Gemperle, a partner at Nisen & Elliott LLC, told AFN. A loan extension is a common tool for keeping delinquencies in check.

However, extensions done wrong can result in liability, Gemperle said. “Loan extensions are a short-term solution that has potential consequences and higher losses down the line,” he said.

The problem is that some lenders will do what is necessary to avoid repossession and higher defaults. “If lenders don’t do loan extensions, then they have a repo,” Micky Watts, senior vice president of indirect lending at Anderson Brothers Bank, told AFN. “When [lenders] are looking at an $8,000 to $10,000 loss, loan extensions make sense.”

However, extensions are inherently risky because the longer a loan is on the books, the tougher it becomes to pay down and the greater the risk of negative equity. “Longer loan terms will only expedite that situation,” said Anil Goyal, Black Book’s executive vice president of operations.

To that end, lenders need to understand that not all used vehicles depreciate at the same rate, and there are opportunities to leverage residual forecasts in the underwriting process to evaluate which cars are better suited for loan extensions, Goyal added.

“[Loan extensions] could be poison for the industry,” Joe Cioffi, chair of the insolvency, creditors’ rights, and financial products practice group at Davis & Gilbert, told AFN. A red flag to watch out for is an unreasonable reliance on loan extensions being used to offset what would be higher monthly payments.

“When lenders are thinking of strategies, it’s important to think: ‘What about the long-term risks associated with that?’” Gemperle said. The longer the loan term, the greater the chances a borrower will face financial hurdles.

Lenders also have to be careful to explain the effect of an extension to the borrower and to ensure that programs pass compliance, Gemperle said. For instance, in November 2018, Santander Consumer USA finalized an agreement with the Consumer Financial Protection Bureau to pay a $2.5 million fine and more than $9 million in restitution after allegations that it misled consumers regarding loan extensions. Santander told consumers that loan extensions would move monthly payments to the end of their loans but failed to explain to consumers how or when the accumulated interest would be repaid, according to the CFPB’s claims.

Santander agreed to settle without admitting or denying the CFPB’s claims.

Another situation with folded lender Honor Finance, which handed over its portfolio to Westlake Financial Services in August 2018, was primarily due to poor practices regarding loan extensions.

“Honor granted an extraordinarily high number of payment extensions to borrowers,” Cioffi said. Although Honor took the practice to a dangerous level, it is common in the industry. “So much so, that S&P Global Ratings is recommending that going forward investors monitor the level of extensions in their deals,” Cioffi added.

Extensions can also increase risk, Cioffi said, because extensions are requested by financially troubled borrowers and allow interest to accrue during the deferral period — something borrowers do not always understand — ultimately increasing the amount to be repaid.

© Can Stock Photo / Andreus

Technology: Data and Analytics

One analyst argues that with the technology and data available for lenders today, there is no excuse for flawed loan extension practices. “The data to decide on loan extensions is more sophisticated than ever before,” said Lou Loquasto, the auto vertical leader at Equifax.

Lenders should be able to use the technology available today to properly vet loan extensions, but each borrower situation is different.

Indeed, tech is playing a bigger role in financing as buyers increasingly look for lenders to provide digital options for communication and payment. Nissan Motor Acceptance Corp. and Toyota Financial Services, for instance, are meeting their customers’ expectations with new web portals, text communications, and mobile apps.

And a number of lenders are partnering with tech companies to make loan applications and servicing more attractive.

BMO Harris Bank, for instance, in December 2018 started to accept online auto loan applications in California through a newly inked partnership with AutoGravity. Earlier this year, Infiniti Financial Services, Kelley Blue Book, Santander Consumer USA, and TD Auto Finance also partnered with the auto marketplace.

AutoGravity’s platform connects car shoppers with lenders and dealers. It provides prequalified finance offers from partnered dealerships listed on the AutoGravity site. Buyers can use their computer or smartphone to browse local inventory for new or used vehicles, shop by monthly payment amount, and apply for financing directly through the platform.

Technology innovations have made access to credit easier for consumers, as well, with alternate ways lenders can evaluate potential borrowers besides traditional Fico scores.

However, “the issue can actually be too much available credit given rising interest rates,” Cioffi said. “Alternatives to Fico that take into consideration bank accounts and check payments will make even more credit available.”

There’s a risk with greater accessibility to credit, and lenders need to be wary. “Consumers can get the false impression that if a lender is willing to make the loan, then they must be able to afford it,” Cioffi said.

With industry apprehension that a market slowdown is near, it is critical for lenders to understand that the next few years will be a risky time to grow the loan business through expansion of criteria. But data and analytics, combined with the proper investments in IT, can help lenders manage their businesses.

The key is to implement an IT strategy that supports its future business model. Alternatively, if a lender is pursuing the wrong business model, then its IT infrastructure will be of little help.

“Where you’re investing your money today might not be correlated with the business model that might be the right model in the future,” Brutti said. “As a captive or as a bank, we’ll try different things, and we’re all trying to figure it out.”

The question is: What is going to be the business model in the future? With subscription services, autonomous vehicles, electric vehicles, carsharing, direct lending — it’s vital for lenders to be prepared for the future of financing.

“We don’t see anything disruptive in the short term,” Brutti said. “We see these potential products in the future, and it’s an opportunity cost. If you don’t do it, somebody else will do it. There is more risk in not doing anything than in trying something. Whoever else does it, it will take that business away from you [in regard to] profitability, customers relationship, loyalty, and potentially sales — that will be one of the risks for 2019.”

“If there’s a threat to the business model, decide how you address it,” Brutti added. “You can do it on your own, and you can pick a partner, you can do a pilot. Then learn how to mitigate risks for each factor.”

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A number of auto manufacturers, finance operations, and government bodies have new people at the helm, ready to leave their marks. The following are AFN editors’ picks for 4 people to watch in 2019:

Kathy Kraninger

Kathy Kraninger succeeded Mick Mulvaney as director of the Consumer Financial Protection Bureau in December 2018. Kraninger’s first official move was to scrap the CFPB’s name change, determining it would be too costly for lenders, she wrote in an email to the bureau staff. She plans to tackle a number of auto finance issues in 2019, including wrongful repossessions, ancillary products, payday lending, and fintech practices.

Michael Manley

Michael Manley, former head of Jeep Brand, was named Fiat Chrysler Auto CEO in July. Manley succeeded Sergio Marchionne, who died that month. FCA said Manley will follow through with the implementation of the 2018-2022 business strategy established on June 1 by Marchionne, a plan that includes forming FCA’s own captive finance arm.  “Marchionne was a dynamic leader, but the decision to form a captive runs much broader and deeper than just one person,” Jack Micenko, bank and auto finance analyst with Susquehanna Financial Group, told AFN.

Maxine Waters

Rep. Maxine Waters (D-Calif.) is the new chair of the House Financial Services Committee and is already considering legislation to undo some of the structural changes former CFPB Acting Director Mick Mulvaney made at the agency, including the reorganization of the Office of Fair Lending. Additionally, a Democrat-controlled House will likely subpoena auto lenders for information about their practices, bumping up the threat of reputational and headline risk in 2019. “The House can’t make any regulations, but it can put practices into the news to get the attention of a congressional committee,” Chris Willis, a partner at Atlanta-based Ballard Spahr LLP and practice leader of the firm’s consumer financial services litigation group, told AFN.

Mark Templin

Mark Templin was appointed the president and chief executive of Toyota Financial Services in August 2018, taking over for longtime executive Mike Groff, who retired. Templin was executive vice president of Lexus International. With an insider taking the helm, Templin “brings a global depth of knowledge and experience in both the finance and automotive sides of the business,” Groff said in the release. “He understands how to meet the needs of our dealer partners and our distributor affiliates.” Groff, who joined Toyota Motor Credit in 1983 as the company’s seventh employee, became president and chief executive in 2013.

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While prime auto lease and loan asset-backed securitizations are projected to remain stable, Fitch Ratings Agency expects the outlook for subprime auto ABS to weaken.

In a 2019 consumer lending outlook, Fitch’s Senior Director of ABS Ian Rasmussen said subprime auto asset-backed securities are more vulnerable due to weaker borrower profiles and industry headwinds inflated by macroeconomic pressures.

Among them, consumer debt is at a record high $13.5 trillion as of Sept. 30, 2018, according to the New York Federal Reserve Bank. Auto loans account for 9% of that total. Additionally, rising interest rates may put pressure on consumers, which Rasmussen said “could push loss frequency higher in 2019.” Fitch predicts three interest rate hikes this year.

Rasmussen noted that these outside pressures will likely impact subprime — not prime — auto securities. “The smaller, deeper subprime lenders’ ABS transactions, which are not rated by Fitch, could be impacted to a greater degree, driving losses to record levels in 2019,” he told AFN in an email.

Fitch’s subprime auto ABS forecast parallels the rating agency’s waning auto finance outlook broadly. Michael Taiano, Fitch’s senior director of financial institutions, said that auto loan and lease sectors are also likely to be negatively affected by asset quality and rising interest rates.

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