The Impact Of The New Bankruptcy Code On Special Finance

4Q2005 Filers Expected to Drop Sharply, Could Cause Mid-2006 Lull in Special Finance Market.

“We expect to have a great fall, and great tax season,” one auto finance company president (who wishes to remain anonymous) said. “But after that, we’ll have to see what it brings.”

Certainly, through the beginning to the third quarter of 2005 there are many reasons to be optimistic. The new codes have led to a huge race to file before they go into effect. Consider that for the first time this decade, personal bankruptcy filings for the first quarter of 2005 actually fell (3.6 percent) from the first quarter of 2004. That has reversed itself very quickly. With the publicity of the new code and the signing of the legislation in April 2005, personal bankruptcy filings have spiked. They are not only being filed at a record pace, but have actually increased from the same period in 2004 by over 12 percent! In many markets, this frenzy is being fueled by advertising blitzes by bankruptcy attorneys suggesting now is the time to file rather than wait until after the new codes go into effect.

Over the next six months, those filers will be discharging at record a pace. That means special finance departments should be enjoying high amounts of traffic of individuals that now are in a position to re-enter the buying market. Combine that fact with the timing related to the first quarter of 2006 and its income tax refund season, it stands to reason that the next seven to eight months should likely generate record production for many special finance departments.

So then, the bankruptcy reform should benefit special finance sales? In the short term, it certainly stands to reason, yes. Looking past the short term of the first quarter of 2006, the outlook is not so rosy.

With the race to file before Oct. 17, 2005, bankruptcy filings will act very much like a tsunami. As tsunamis approach, the advancing waves suck the water out ahead of it to fuel the impending wave. Indeed, the same will be the case for the bankruptcy filings. The filings over the next six weeks will indeed pull filers out of the 4th quarter of 2005, and the first quarter of 2006. Adding to that is the fact that once the new code takes effect, filers must first go through mandatory consumer credit counseling within six months of filing. The fourth quarter 2005 and first quarter 2006 filings and the subsequent discharges stand to be miniscule compared to recent years past.

Additional consideration should be given to the fact that many of the filers will no longer be able to file Chapter 7. Many will be forced into Chapter 13s and a five-year repayment plan. Currently, very few auto finance companies have programs that will allow dealers to finance a Chapter 13 filer.

Another executive from a renowned special finance auto finance company, also wishing to remain anonymous commented, “Frankly, right now we don’t have any programs for those in consumer credit counseling or Chapter 13s. It’s something we may have to look at, but it will be a fluid environment, and we will likely wait to see what it looks like when we get there rather than leading the market.”

One lender interviewed willing to be identified was Aaron Dalton, a senior vice-president with Prestige Financial Services, a Sandy, Utah-based special finance lender. Dalton was a bit more optimistic for the post-October filers stating, “We believe that the elimination of the retain/ride-through provision coupled with the higher redemption value standards (two options that have in many cases been extremely attractive to filers under pre-change law) will force a much higher percentage of filers to surrender [their existing vehicles] than did before, creating new car buyers that the old law didn't.”

Dalton also added, “In a recent ABI (American Bankruptcy Institute) web-cast seminar about the changes, the consensus of the expert panel comprising of trustees, debtor and creditor attorneys, academics, etc. was that based on current filer profiles, the new law would probably only reduce the total volume of those eligible to file Chapter 7 by less than 5 percent - by far the lowest figure we've heard, and significantly lower than our own estimate.” He went on to add, “They also reiterated, resoundingly, my point about the higher number of surrenders, as well as feeling the percentage of successful Chapter 13 cases would actually decrease due to some of their more stringent requirements.”

Dalton agreed strongly on point, that there would be a period where their will be a lull in the market. The length of the lull will be determined by the reaction time of lenders to the new issues in the market, and the actual number of individuals forced into a Chapter 13 rather than the intended Chapter 7. So if we are to assume their will be a lull, how big will it be? When will it hit? And how long will it last?

Many special finance managers and auto finance executives have been speculating on these items since before the new code were signed into law. A fact that should help mitigate the impact is that while many special finance customers have indeed filed bankruptcy, the majority of deals consummated each month do not involve someone that was discharged from bankruptcy in the preceding six months.

“It just isn’t the case,” commented one company executive. The majority of deals booked by the higher-volume auto finance companies fall into the 525 and above Beacon or FICO credit score range. Someone facing eminent bankruptcy or someone just having discharged a Chapter 7 simply doesn’t fall into that credit score range.

The lull of filers stands to be as long as six months. Eventually the pace of those seeking credit protection will equal and exceed the current pace, with the standards the new code puts into place, it certainly won’t occur overnight. With current discharges taking approximately 90 days on typical cases, and with larger responsibilities being placed on consumers, their attorneys and trustees, that is likely to extend. All told, it could be the end of 2006 before the discharges begin to occur at the pace the market has become accustomed.

Who will it impact the most? The niche market that many dealers have enjoyed growing success over the last 24 months is the Open Chapter 7 market, and it potentially may be impacted the hardest. Here, dealers are marketing to individuals beginning the day after the consumer files for Chapter 7 bankruptcy protection. Many auto finance companies will fund the dealers retail installment contracts as soon as the buyer attends the 3-4-1 meeting, the meeting of the creditors – some even before. Now, with the uncertainty involved – the consumer could be forced into a Chapter 13 rather than the expected Chapter 7, dealers will have to be more cautious on deliveries for fear of being put into the unwanted position of having to unwind delivered deals.

Likely, by time that lull in filers hits and that void washes its way through the system, it may be the first quarter of 2007 before the market fully recovers.

All in all, this predicted lull in the market should not be looked at as if the special finance market is drying up. Dalton feels that the opportunities will even out. Essentially looking at the total number of deals available in the market throughout the next 18 months, it is not likely that there will be fewer people with sub-prime credit in the market.

The net effect of the changes for the bankruptcy reform will likely be a consistent number of contracts funded over a two-year period by the auto finance companies. The difference will be part of those, that in the past would have taken place in mid- to late-2006, simply will be ratcheted ahead three to six months, to make the upcoming months some of the best the special finance industry has seen in many years.

Vol 2, Issue 9