Auto Loan Analysis, Pt. 3

Part
01
of four
Part
01

Auto Loan Aggregators: TAM

There is no publicly available information regarding the market size for auto loan aggregators within the United States. However, we were able to estimate that the market size of auto loan aggregators/online brokers would be between $6.55 billion and $14.11 billion if we were to take into that between 13% and 28% of US auto loan consumers secured their lending online

THE AUTO LOAN AGGREGATOR MARKET

  • Economic analysts and research organizations have assessed the auto loan market as a whole within the U.S. and calculated the market share for the different lender types, including banks, captives, credit unions, finance companies and 'Buy Here, Pay Here' type businesses (BHPH).
  • As auto loan aggregators are a relatively new lender type, their presence is yet to be quantified by leading financial organizations and economic researchers. This is inherently difficult to do given the business model of aggregators, who typically offer products from a variety of different organizations and traditional lenders, essentially acting as brokers rather than lenders. As a consequence, an auto loans aggregator could, in theory, contribute to market share for any of the lender types detailed above.
  • This provides the possibility that auto loans aggregators have the potential to overtake the whole auto loan market, which as of 2019 had over $1.22 trillion in loan holdings, generating over $47.2 billion in revenue in 2016 or $50.4 billion adjusted for inflation in 2020 (industry growth notwithstanding).
  • This would be unrealistic, however, given that in 2019 only 13% of US auto loan consumers secured their lendings online, even though 28% of consumers indicated that they prefer securing their auto loans online.
  • If we were to use those figures as the potential market for auto loan aggregators/online brokers, we could estimate that the market size would be between $6.55 billion and $14.11 billion (13%-28% * 50.4 billion). Using these percentages, we could also estimate that the online loan holdings for auto loan aggregators will amount to $158.6 — $341.6 billion (13%-28% * 1.22 trillion).
  • The estimated annual market size does not consider the commercial terms dictating fees or revenue split between auto loan aggregators and their partners. It represents the potential revenue generated via aggregator channels.
  • 63% of consumers applied for their current auto loans through the dealership. However, innovations and partnerships with dealerships as well as the in-dealership presence could extend the available customer base.

RESEARCH STRATEGY

We began our research by going through reputable financial news databases such as the Financial Times, Markets and Markets, Business Insider, and Forbes in order to locate the market size of the US auto loan aggregator market. While there were several reports that addressed the specific area of interest, they were paywalled. We then widened our search to the auto loan industry in hopes of finding information on the share of the online loan brokers. We located a report by Experian that provided a concise breakdown of the US auto loan industry by lender type but it still did not provide information about the aggregator sector. We also found the recent market size for the whole auto loan industry and a credible marker for the percentage of the market accessible to aggregators. These figures were then used to extrapolate a potential market size.
An effort was made to correlate the insurance aggregator market share with the auto loan sector, however, this proved difficult because of the differing statistics and market forces that influence both markets.

Part
02
of four
Part
02

Auto Loan Aggregators: Over- and Under-Served Markets

The auto-loan aggregator market has seen constant growth since 2010 with the market over-serving the Gen X population, and under-serving the Gen Z population.

Overview

  • The US vehicle financing market is predicted to reach $1,366 billion in the next three years.
  • In 2020, total auto sales debt rose to $1.22 trillion, with 17 million cars being sold in the US. [9]
  • Over 85% of new vehicles purchased in 2019 were financed.
  • Close to half of all Americans (over 44%) rely on auto loans to afford their vehicles.
  • In 2017, auto loans made up approximately 9.27% of the total US debt, showing a steady growth seen since 2010.


Over-served segments

  • Generation X customers have the largest amount of auto loan debt, which reached $21,570 per person at the end of Q2 in 2019. These consumers make up the over-served market segment for auto loan aggregators.
  • Following them is baby boomers with an average personal debt of $18,759, and millennials with $18,201.
  • In 2018, people between 45 and 64 years owed approximate $20 billion in auto loans, the highest of any other cohort. [5] They were followed by consumers aged 30-44 who owed approximately $17 billion.
  • Millennials have now surpassed baby boomers in auto loan share. According to Experian, millennials hold 30.1% of outstanding auto loans while baby boomers hold 29.1%.
  • Although generation X and baby boomers have a higher amount of auto-loan debt, millennials saw the highest increase in auto loan debt, with a 3% increase in Q2 in 2019.
  • Overall, millennials' auto loan debt increased 28% since 2012, with generation X closely following with a 27% increase.
  • This rapid increase is largely due to the job environment and vehicle cost. Millennials make up over 40% of the US workforce. As the number of working millennials increased, the amount of auto loans also grew.
  • Although this cohort has had the greatest increase in overall auto loan debt, studies have shown that millennials experience the lowest booking rates as a result of low credit.
  • As millennials are becoming more dominant in the workforce, auto loan companies have started implementing strategies that specifically target them.

Under-served segments

  • Generation Z consumers are the most under-served age demographic, with an average debt of $14,272.
  • As more generation Z are entering the workforce, they are experiencing a higher rate of growth in the number of people taking auto loans annually when compared to generation X or baby boomers.
  • Auto loan aggregators are most concerned about younger people that have investable assets as the people that usually take out auto loans are college graduates who are now employed full-time.
Part
03
of four
Part
03

Auto Loan Aggregators: Buying and Shopping Habits

U.S. consumers who use auto loan aggregators are mostly middle-income millennials. Combining the findings below, users of auto loan aggregators in the U.S. would be social shoppers with a preference for omnichannel shopping. They spend about 50% of their income on luxury item and are influenced by external forces such as by user-generated content. Their shopping journey usually entails transitioning their consumer data from their devices to brick and mortar stores, and back.

Millennials Insights

  • About 68% of millennials prefer the convenience of omnichannel/hybrid shopping that entails transitioning their consumer data from their devices to brick and mortar stores, and back. Millennials are omnivorous shoppers and are likely to use every available avenue in their purchasing journey; however, while younger millennials are more likely to complete their shopping in offline avenues, older millennials are the most likely to purchase via mobile.
  • Overall, when millennials shop both in-store and online, there is a higher chance that the purchase will be completed in-store than online.
  • Millennials consider shopping to be a shopping event with the majority reporting that they shop with others at least 50% of the time and 60% reporting that they seek advice from friends before making a purchase. Research has found that 68% of consumers are influenced by social media posts and 84% revealed that their purchase was influenced by user-generated content.
  • A grand majority (90%) of millennials search for product reviews online and most trust consumers' reviews more than the opinions of people they know. Additionally, 82% stated that their purchase decisions were greatly influenced by word-of-mouth.
  • Millennials tend to spend more on conveniences and comforts that older generations. About 60% spend over $4 on a cup of coffee, 69% buys more clothes than they need, and 70% are willing to spend extra on eat outs. Furthermore, about 50% spend on taxis and ride sharing services compared to 15% of Boomers and 29% of Generation X.
  • Overall they spend more annually on groceries, restaurants, gas, and hobbies and less on furniture, television, pharmacies, and traveling than other generations.
  • Millennials are estimated to spend about $322.5 billion annually, with 330 transactions of about $54.91 on average. Retail, travel, food/convenience, other retail, and restaurant account for the largest portion of their expenditure.

Middle Income Earners Insights

  • A huge portion of Americans' expenditure is categorized by economists as 'luxuries,' and middle-income earners spend about 50% of their income on luxuries, and the remaining half on necessities. Interestingly, luxuries are defined by the Deutsche Bank as services and goods "consumed in greater proportions as a person’s income increases and necessities as those goods or services that make up a smaller proportion of spending as a person’s income increases." Therefore, ordering from McDonald's would be considered luxurious while buying a lottery ticket or smoking are necessities.
  • According to the Organization for Economic Co-operation and Development (OECD), middle-income earners account for the highest share of consumption in the United States. They make up 60% of the population and account for 63% and 64% of the national income and spending, respectively. This is the only demographic whose share of consumption/spending is greater than both its share of the population and income.

RESEARCH STRATEGY

The information on the buying and shopping habits of U.S. consumers who use auto loan aggregators was not readily available on the public domain. This is probably because no research has been conducted specifically on the subject. Our research entailed searching through media reports, financial resources, marketing sites, and other relevant resources. Therefore, the research team leveraged a previously-completed report on the demographics of users of loan aggregators to provide the required information. The report found that users of auto loan aggregators are mostly men and women (in equal measure) aged between 25 and 40 years with lower education levels and middle income levels.

Therefore, the research team concentrated on finding insights on the shopping habits for the aforementioned demographic. We focused on providing information on millennials since they are currently aged between 26 and 40 years. While more scarce than the information on millennials, we also tried to provide some data on middle-income Americans.

Notably, while statistics indicate that Americans with a high school diploma or GED are at the lower end of the income spectrum with an average income of about $38,000, our previous findings established that users of auto loan aggregators earn about $6000 monthly (or $72,000 annually). This puts them in the middle income bracket. We elected to focus on middle-income earners with the assumption that users of auto loan aggregators belong to the higher-income spectrum of Americans who have only attained high school diplomas. This was also supported by the fact that the average millennial in the U.S. belongs to the middle-class category.
Part
04
of four
Part
04

Auto Loan Aggregators: Regulatory Concerns and Barriers

Companies entering the marketplace lending industry must observe several regulations and Federal laws, as well as state laws. Some of these regulations include usury laws, FTC and FDIC regulations, as well as consumer protection laws.

Insight#1: Usury Laws and the Madden Case

  • Most states have regulations that limit the rate interest lenders may charge on consumer loans. While some states impose a fixed maximum rate, others attach the rate to a floating rate index.
  • The online nature of loan aggregators creates a severe challenge, as the variables mean that a lender would have to set different rates depending on the borrower’s state. If an exemption is not provided, loan platforms are not able to conduct business consistently across jurisdictions.
  • Considering that loan marketplaces usually cater to consumers that would be otherwise denied, interest rates have typically to be higher than average to offset expected losses, which is also tricky with usury laws. State laws may also influence how much lenders can limit the fees for delinquency or returned payments, which is another compliance burden for loan marketplaces.
  • To address these barriers, FDIC-insured financial institutions adopt “rate exportation rules,” a set of federal laws and court decisions that remove most state usury restrictions for some financial institutions, like banks.
  • Some loan aggregators use Funding Banks as a way to leverage the same conditions. For instance, the LendingClub and Prosper are both funded by WeBank, a Utah-chartered industrial bank. Since Utah law does not limit interest rates (as of April 2019), the WeBank relies on DIDA to fund Borrower Loans for both marketplaces with interest rates subject to a written agreement, which allows the marketplaces to escape the limitation of other states.

Madden v. Midland Funding

  • The variations between state laws and interest limitations are already a concern, as aggregators must find a Funding Bank to address the issue. However, over the past five years, the Second Circuit’s ruling over the Madden v. Midland Funding case raised several questions and made the landscape even more complicated to navigate.
  • The lawsuit did not involve a loan aggregator. However, it put into question the “valid-when-made” principle, which predicts that when a bank sells a debt or assigns a loan to a third-party, the interest rates that were valid when the bank made the deal carry to the new holder. The Second Circuit concluded that preemption did not apply to the third-party debt buyer, which made the marketplace industry question if it would affect the transactions between Funding Banks and marketplaces.
  • Under the National Bank Act (NBA), banks are allowed to make loans nationwide at the rates and fees of the state the bank is based. The ruling determined that the NBA preemption would not be extended to the third-party.
  • Although it was only binding in the states under the Second Circuit (New York, Connecticut and Vermont), there was a lingering fear that other jurisdictions would adopt the same view. In 2017, an Illinois federal court denied a motion to dismiss usury claims against a non-bank assignee of loans originated by a national bank citing Madden. The case was subsequently settled on other grounds, but it shows at least one court referencing the Madden decision approvingly and in a case involving loans.
  • In 2017, the Madden ruling was dismissed since New York law does not allow a private right of action for criminal usury violations. In 2019, a settlement was presented to the federal district court that would end the litigation.
  • The decision of the Second Circuit was widely criticized for ignoring the “valid-when-made” principle; however, no legislative or regulatory pronouncement on the issue was made.
  • In June 2019, a class action lawsuit filed in New York reignited the discussion. In Cohen v. Capital One Funding, the complaint says that New York’s usury limit is not preempted under Madden and is therefore usurious.
  • In November 2019, the OCC and FDIC proposed new rules to confirm the "valid when made" principle and fix the disturbances created by the ruling; nonetheless, it is not the first time the government tries to address these issues. For instance, in 2018, the House of Representatives passed H.R. 3299, a bill that would codify the loans, but the bill died in the Senate due to the uproar of consumer groups claiming that would advance predatory lending.

The Impact on Loan Aggregators Entering the Market

  • The Madden decision challenged marketplace lenders for years, and it affected the relationship between funding banks and marketplaces, especially those entering the market. As a result of Madden, some marketplace lenders and their funding banks have already revised their business relationship to address concerns, and some marketplace loans have limited eligibility criteria to loans that comply with usury rates in Second Circuit states.

Insight #2: Guidelines for Funding Banks and The Bank Service Company Act

  • As previously noted, it is often advised for marketplace lenders to utilize the services of a Funding Bank to operate a loan platform, especially to enable preemption of usury laws. Nevertheless, several concerns come with it.
  • In the last few years, federally insured institutions have been subjected to new guidance on programs they have with third-party service providers. They are now required to conduct due diligence on proposed third-party arrangements, monitor the service provider, and enter into agreements that protect the bank from risk.
  • These new guidelines further add to the Bank Service Company Act, which requires providers to comply with laws and regulations applicable to the banks and subjects them to supervision and examination by the federal banking regulator.
  • Depending on how a program or platform is structured, various state licensing requirements could potentially apply. Even when a Funding Bank is used, participants may need state licenses in order to perform certain functions in the origination, funding, purchasing, or servicing of loans.
  • Another issue aggregators entering the marketplace need to be aware is that the new rules proposed by FDIC do not address the “true lender” issues, which states that the entity that makes the loan and then assigns to the third-party is the true lender.
  • It was left out on purpose, as the OCC and FDIC are not favorable to non-banking institutions using bank charters to avoid restrictions. The FDIC stated in the preamble of the proposal that it would “view unfavorably entities that partner with a State bank with the sole goal of evading a lower interest rate established under the law of the entity’s licensing State.”

The Impact on Loan Aggregators Entering the Market

  • Even with the growth of loan aggregators, only a few FDIC-insured banks currently operating as Funding Banks. Trade publications indicate that these banks are receiving scores of inquiries related to serving as a Funding Bank for marketplace lenders. The high demand for Funding Banks is likely to increase the fees charged. Some may also limit the number of lenders they work with to mitigate risks.
  • Additionally, the increasing scrutiny by regulators has led to increased due diligence and compliance requirements for marketplace lender partners. Some banks are also opting to emulate aggregators by offering bank loans through an online platform, often branded differently from the bank’s main website, seeking to reduce the risk of litigation under the “true lender” theory.
  • The rise in scrutiny also makes it challenging for new partners, as Funding Banks may impose additional burdens or restrictions if they do not possess a tracking record, considering they can even meet the bank’s requirements, which are now more strict concerning legal and regulatory compliance.
  • Violation claims are increasing, stating that marketplace lenders are the “true lenders” and are only using bank lenders to evade compliance with state usury limitations, licensing regimes, and consumer protection laws.
  • Analysts estimate that marketplace lending arrangements with Funding Banks will likely become more complex and costly.

Insight #3: The Federal Trade Commission

  • Compliance with federal laws is a significant issue for loan aggregators. These laws are enforced by numerous regulatory agencies, notably the Federal Trade Commission (FTC), including in online lending transactions.
  • The FTC supervises non-bank entities and has ample authority to act if it perceives unfair competition and deceptive acts and practices. Lately, marketplace lenders have endured increasing scrutiny by the FTC, resulting in multiple lawsuits.
  • These lenders are obliged to comply with Section 5 of the Federal Trade Commission Act, which deems as unlawful any “unfair or deceptive act or practice in or affecting commerce.” The FTC also enforces the Credit Practice Rule on these companies, which was initially intended for banks, but is now applicable to other lenders to protect consumers against abuse term and conditions in credit contracts.
  • Aggregators need to ensure their contract complies to all the requirements of the Credit Practices Rule, which includes prohibiting contracts to impose the following:
  • 1. Require the borrower to generally waive the right to notice and the opportunity to be heard in the event of a lawsuit.
  • 2. Borrowers should not be required to waive the benefit of any laws that protect their real or personal property from seizure or sale to satisfy a debt.
  • 3. Contracts are prohibited from assigning the creditor the borrower’s wages or earnings unless the assignment is a preauthorized payment plan established at the time of the debt, the borrower may revoke the assignment, and it only applies to wages or earning already earned at the time of the assignment.
  • 4. Pyramid late charges, in which multiple late charges are imposed based on a single late payment, are also prohibited.
  • Another essential issue loan aggregators should consider when designing their contracts is how the FTC will perceive the terms. Burying relevant provisions in long documents without adequately drawing attention to them could be subject to challenge as an unfair or deceptive practice.

The Impact on Loan Aggregators Entering the Market

  • The FTC is currently focusing on the marketing practices of online lenders, and it has filed complaints about numerous aggregators. The costs of going through litigation and the reputation hits could potentially hindrance a new company's capacity to survive.
  • In 2018, it filed a complaint in federal court against the LendingClub, claiming the platform engaged in deceptive practices, including not disclosing hidden fees and telling customers they were approved when they were not. The FTC also accused the platform of withdrawing funds from consumer's bank accounts without authorization and not providing the required privacy notices to borrowers. The lawsuit is pending in the Northern District of California, after the parts failed to settle.
  • The FTC claims led to another lawsuit, this time from investors that claimed they were misled about the company's practices, and not informed about the hidden fees and deceptive practices. The U.S. District Court for the Northern District of California eventually dismissed the case saying the allegations were not enough to support the claims.
  • The LendingClub, which was once a Wall Street favorite, plummet after the allegations were brought against the company. The company is yet to recover from the public distrust and investors' concerns over its practices.

Insight #4: Consumer Protection Laws

  • Internet loan platforms must comply with several federal and state consumer protection laws. These laws usually require the lenders to provide consumers with specified disclosures regarding the terms of the loans, prohibits discrimination, and restrict the actions that a lender can take to receive delinquent or defaulted loans.
  • Since loan aggregators are internet-based, they must also consider the legal requirements for electronic contract and consent, and consumer authorization for electronic payments from their bank accounts.

Truth in Lending Act

  • The federal Truth in Lending Act (TILA) and it's implementing Regulation Z, requires lenders to provide standardized and understandable information to borrowers, including the terms and conditions of their loans, as well as any possible changes.
  • TILA usually applies to the Funding Bank or licensed entity; however, it allows borrowers to assert claims for violations against any assignee of the loan, in this case, the aggregator. Funding Banks and lenders have to ensure that the information provided to borrowers is compliant with TILA requirements.

Equal Credit Opportunity Act

  • The Equal Credit Opportunity Act (ECOA) prohibits lenders from making any credit determination based on the borrower’s race, color, sex, age (with exceptions), religion, marital status, or national origin. It also refrains lenders from using the fact that the applicant’s income derives from a public assistance program or that the applicant has exercised its rights under the Consumer credit Protection Act to make decisions.
  • The ECOA must be observed during all stages of the process, including advertising, application, approval process, and collection. The lender must also validate its credit scoring system periodically.

The Impact on Loan Aggregators Entering the Market

  • TILA places restrictions on the advertisement efforts of lenders, which could be overwhelming for aggregators trying to enter the market, regardless if a Funding Bank is involved or not. Whenever a term such as loan or interest rate is used to trigger consumer’s attention, other disclosures must be made.
  • The information that must be provided for closed-end loans is different from the requirement that applies to revolving or open-end loans. Based on the type of loan involved, the requirement may also differ.
  • Another aspect new aggregators must pay attention to is the structure of the lending platform, as it must comply with ECOA requirements and state laws. The criteria used to determine creditworthiness must not have a disparate impact based on any Prohibited Basis.

Insight#5: Electronic Commerce Laws

  • Aggregators must comply with the federal Electronic Signatures in Global and National Commerce Act (E-Sign Act) and similar state laws, as they execute registration agreements and process credit transactions in electronic form.
  • The Act authorizes the creation of legally binding and enforceable agreements using electronic records and signatures. The E-sign Act ensures that borrowers can access the information in the electronic form, and may only give consent to receive electronic records if it is demonstrated that they can access the information.
  • Furthermore, any information required by law to be provided in writing can be made available electronically to a borrower only if the consumer affirmatively consents to receive the information electronically, and the lender clearly and conspicuously discloses certain essential information to the borrower before getting his or her consent.
  • When it comes to payments, marketplace lenders typically rely on financial institutions to fund Borrower Loans and to receive payments over the Automated Clearing House (ACH). The Electronic Funds Transfer Act (EFTA) establishes the rights, responsibilities, and liability of consumers who use electronic fund transfers and of financial institutions and certain other parties that offer these services.
  • These regulations require that lenders that wish to debit a borrower’s account for payment automatically must obtain written authorization. However, under the EFTA, aggregators cannot require consumers to make payments by electronic means, albeit it may provide incentives.

The Impact on Loan Aggregators Entering the Market

  • Appropriate customer authorization and compliance with EFTA regulations are vital for online aggregators. Important to note that recent cases have shown that placing the authorization within another document may not suffice as adequate consent.
  • Courts are scrutinizing online platforms. For example, the Seventh Circle has determined that an arbitration clause in online terms of use, eight pages into the agreement, was not sufficient to classify as proper notice.
  • Two courts have considered that requiring consumers to sign an electronic funds transfer authorization for loan payments but allowing them to cancel at any time is a violation of EFTA regulations.
  • These rulings indicate a significant risk of violation and potential claims. If an aggregator does not provide payment options or gets the proper consent, it will likely be subject to challenge and litigation.



Sources
Sources

From Part 01
Quotes
  • "The Global Automotive Finance Market is likely to grow in the coming years with impetus from strategic collaborations among companies from across the world. According to a report published by Fortune Business Insights, titled “Automotive Finance Market Size, Share and Global Trend by Loan Provider (OEMs, Banks, Financing institutions"
  • "Browse Complete Report Details: https://www.fortunebusinessinsights.com/industry-reports/automotive-finance-market-100122"
Quotes
  • "11. Snapshot on Digitization of Vehicle Finance 11.1. Operating Model Transition Traditional Vehicle Finance Model Digital vehicle Finance Model 11.2. Operating Models in Digital Lending Ecosystem 11.3. Online Auto Lending Market Ecosystem 11.4. Online Auto Lead Generation 11.5. Major Company Profiles of Auto Loan Aggregators and Marketplaces LendingTree DealerTrack Finance Express Credit Union Direct Lending RouteOne 11.6. Major Company Profiles of Auto Lead generation Companies BlueSky CyberLead Auto Credit Express"
Quotes
  • "Provider Type Outlook (Revenue, USD Billion, 2015 - 2026) Banks OEMs Other Financial Institutions "
Quotes
  • "Another irritant to the monopoly previously enjoyed by the captives and large lending bodies are digital aggregators / brokers. This model has become common in other industries such as insurance (gocompare), travel (expedia), and housing (zoopla) and is now being applied to vehicle finance. "
  • "Aggregators offer finance for car buyers from a number of different lenders. CarFinance247 for example “compares products from 18 of the UK’s top lenders to get you the best deal” and stresses “it is a broker not a lender”"
Quotes
  • "In some markets, such as the United Kingdom, Italy, and Germany, aggregators claimed more than one-third of market share in 2017"
Quotes
  • "13% of U.S. consumers acquired their most recent auto loan online"
  • "63% of US consumers applied for their current automotive loans through the dealership"
  • "More than a quarter of consumers (28%) listed online financing as their first choice for their next automotive loan. "