Bankruptcy

Auto Title Lending Data: 65% Repossession Rate?!

By Adam Levitin

Todd Zywicki has an article on auto title pledge lending in the Cato Institute journal Regulation that cites unnamed "industry sources" as stating that default rates on auto title loans are 14-17%, while repossessions occur only in 4%-8% of cases and in 20% of those cases the borrower redeems the car. Todd also reports APRs of 120-360%. From this (and borrower characteristics) Todd concludes there's no basis to claims that auto title lending is predatory.

These numbers long seemed too good to be true to me?they would imply either huge profit margins (which Todd denies) or huge overhead costs (Todd's explanation). They also seemed highly skewed by the fact they were counting loans rather than borrowers. Title loans are 30-day loans that can be rolled over, but a roll-over counts as a new roll, which effectively inflates the denominator for default rates. 

I actually found some real data on title lending, and it seems to tell a very different story than Todd's unnamed industry sources.

Following a change in Tennessee's auto title pledge law, the Tennessee Department of Financial Services put out two reports (here and here) on auto title lending in the state based on its examinations of title lenders. The 2008 report has data from 2006. There were 139,319 new title pledge loans made in Tennessee in 2006 (roll-overs excluded), all for $2,500 or less. The average loan was $557.70.

By my calculation, the duration of the average loan was 4.95 months (it actually might be longer, but the report lumps together all longs with 11 or more rollovers?I treated them as all having exactly 11 rollovers for my calculations), meaning there were on average approximately 4 roll-overs or that the real term of a title loan was 5 months on average. 88% of loans outstanding had rolled over at least once. 

Tennessee title pledge lending resulted in 18,199 vehicles being repossessed in 2006. While there is not perfectly matched data on loans and repossessions (repossessions in 2006 include loans made in both 2005 and 2006), if we assume a steady level of auto title lending, this translates into 13% of loans resulting in a repossession rate. That alone is significantly higher than the rate reported by Zywicki. But when the roll-over rate is accounted for, we see that 65% of consumers taking out a title pledge loan had their cars repossessed.

Even if we assume that 20% of those borrowers redeemed their cars, per Zywicki's sources, it still means that 51% of borrowers lost their cars. (Also, remember that not every default results in a repossession because some cards aren't worth repossessing or can't be located). That's a very different story than presented by Zywicki's numbers. When over half of borrowers find their loans result in a loss of highly oversecured collateral (some studies cited by Zywicki find a LTV of 50-67%), that sure looks predatory to me. 

A second point is the cost of title loans. I'm not sure where Todd is getting his interest rate data. He doesn't cite any sources. (In fairness to him, the format of Regulation doesn't have footnoting.) The only good source I've seen is an appendix to the 2006 Tennessee DFI report. It's pretty much impossible to calculate any kind of general range of rates from this data. The APR, for all of its flaws, still remains the basic unit of comparison. Todd doesn't report in terms of APR, which makes me uncertain what he is in fact reporting. If it is stated rates, that's quite different (and generally much lower) than actual APR. To give meaningful numbers, one has to convert fees (application fees, processing fees, physical possession fees, rollover fees, etc.) into interest, add to the stated rate for the monthly loan term, and then compound for the average length of a loan, and then annualize to get an APR. In Tennessee that means a loan with a statutory maximum 2% monthly interest rate and 20% fee results in an APR of 648% based on an average 5 month term, not 264% (you've got to compound!). For a year's term, the cost would be 987%. 

A third point of interest--Tennessee has an (extremely high) pricing cap for title loans:  22% per month.  But only about 60% of lenders are pricing at the cap. A substantial minority are pricing beneath it. And the industry has healthy profit margins--13% on average before taxes. (And this doesn't include money taken out by owners in the form of salary or other benefits). That doesn't fit with Todd Zywicki's explanation of low margins due to high overhead costs and stiff competition. To me these sort of margins suggest that the usury cap isn't restricting credit in a major way and that it might be too high.  

Now maybe title lending in Tennessee is just different from everywhere else. For example, if Tennessee permitted much higher rates, then maybe the industry is able to accommodate a riskier borrower base, which would translate into more defaults and repossessions. I have no way of knowing if Tennessee is unique or typical, but the Tennessee data certainly makes me hesitate to accept Todd Zywicki's conclusions about title lending.

A final thought: this Tennessee Department of Financial Services report is really good. It's a shame we don't see more of this sort of study from state bank regulators, and that they don't coordinate studies. I think this sort of data is a real service for policy issues. Hopefully this sort of examination-based study is what we will see the CFPB producing.

So here's a question for Credit Slips readers: am I reading this Tennessee data correctly? Any thoughts on its interpretation? 

Full post as published by Credit Slips on January 04, 2011 (boomark / email).