Legislature(2005 - 2006)BUTROVICH 205

02/23/2006 01:30 PM TRANSPORTATION

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Heard & Held
Heard & Held
              SB 300-MOTOR VEHICLE NEGATIVE EQUITY                                                                          
CHAIR HUGGINS announced SB 300 to be up for discussion.                                                                         
SENATOR  RALPH   SEEKINS,  Alaska  State   Legislature,  sponsor,                                                               
explained  that  SB  300 updates  the  definition  of  "principal                                                               
balance"  in   the  Alaska  Retail   Installment  Sales   Act  to                                                               
accommodate the  proper disclosure of  negative equity.   It also                                                               
clarifies  how  negative equity  within  a  lease arrangement  is                                                               
handled.   At one time,  lending institutions  required borrowers                                                               
to  monetarily  participate  in   purchase  transactions.    Down                                                               
payments of 25  percent were common, and term loans  were held to                                                               
a maximum  of 36 months.   Over the last several  years, however,                                                               
these  guidelines have  gone by  the wayside.   The  strength and                                                               
stability  of  the national  economy  have  spurred consumers  to                                                               
demand lower-payment loans along with greater value.                                                                            
He noted that banks, credit  unions and acceptance companies have                                                               
accommodated  the marketplace  by  offering  low-down or  no-down                                                               
payment options,  as well as lengthening  the allowable repayment                                                               
period; this is particularly evident  in retail auto sales, where                                                               
qualified  buyers may  opt  for 100  percent  financing over  the                                                               
longest possible term.   As a result, the point  in time at which                                                               
the  vehicle's market  value exceeds  the outstanding  balance on                                                               
the loan occurs much later than it otherwise would.                                                                             
SENATOR KOOKESH arrived at 1:40:04 PM.                                                                                        
SENATOR SEEKINS  continued, explaining  that until this  point is                                                               
reached,  the  owner's  equity   position  is  "upside  down"  or                                                               
"negative" -  the auto's value  is less than the  remaining loan.                                                               
When the owner  wants to trade for a different  vehicle, a dealer                                                               
must figure out how to accommodate  the loan payoff in the trade-                                                               
in.   At  one time,  it  was common  practice in  some states  to                                                               
simply  inflate the  price  of  the car  enough  so the  trade-in                                                               
covered the  amount owed; the  negative equity  then disappeared.                                                               
However, it  failed to  describe the  transaction mathematically,                                                               
and this practice fell into disfavor over time.                                                                                 
He noted  that today new  vehicles may be sold  at non-negotiable                                                               
prices,  such  as when  there  is  a factory  incentive  program.                                                               
Furthermore, the  Federal Reserve Board has  provided guidance on                                                               
this  issue  through  revisions to  Regulations M  and  Z,  which                                                               
control  the  manner  in which  lease  and  credit  transactions,                                                               
respectively,  are  disclosed.    Regulation  M  was  revised  to                                                               
provide a  dedicated disclosure  line on  the lease  agreement in                                                               
cases where a prior loan or  lease balance - negative equity - is                                                               
rolled  in  to the  new  lease  transaction.   Regulation  Z  was                                                               
revised  to  alter  the definition  of  "down  payment,"  thereby                                                               
solving  the  negative-equity issue  as  it  pertains to  a  loan                                                               
transaction, Senator Seekins reported.                                                                                          
He  said  the  vast  majority  of banks  and  credit  unions  are                                                               
federally  regulated and  follow federal  disclosure laws;  state                                                               
laws don't  come into play.   However, acceptance  companies like                                                               
GMAC  or Ford  Motor Credit  must follow  both federal  and state                                                               
laws.  The dual-adherence requirement  has created a disparity in                                                               
the manner  in which  loan and  lease transactions  are disclosed                                                               
when there is  negative equity in Alaska.  While  federal law has                                                               
been  revised  to  accommodate this  situation,  Senator  Seekins                                                               
said, state law hasn't been.                                                                                                    
He concluded, saying  SB 300 resolves this  disparity by updating                                                               
the  definition of  "principal  balance" as  it  pertains to  the                                                               
state's disclosure requirements for  retail sales contracts found                                                               
in Title 45, Chapter 10.   It also adds corresponding language to                                                               
Chapter 25  pertaining to  the handling  of negative  equity with                                                               
respect  to lease  agreements.   These modifications  bring state                                                               
and  federal  law into  alignment  and  resolve the  concern  for                                                               
acceptance companies that do business in Alaska.                                                                                
1:43:03 PM                                                                                                                    
SENATOR  COWDERY asked  how dealers  and car  financing companies                                                               
currently address this situation.                                                                                               
SENATOR  SEEKINS   answered  that  they  generally   try  to  get                                                               
additional  cash  down  payments,  for   example.    In  his  own                                                               
dealership the previous week, a  customer had $19,000 in negative                                                               
equity  on  a  vehicle;  it was  eight-year  financing,  and  the                                                               
dealership could  do nothing to help.   "If we sell  the contract                                                               
to  a bank,  we're  OK," he  added.    "We can't  sell  it to  an                                                               
acceptance  company."   He  pointed  out  that dealerships  would                                                               
rather do business with acceptance  companies, through which they                                                               
get preferable  interest rates and  additional cash  bonuses from                                                               
the manufacturer.                                                                                                               
1:45:11 PM                                                                                                                    
SENATOR  COWDERY  asked  whether  a  loan would  be  made  to  an                                                               
individual if there was negative equity.                                                                                        
SENATOR SEEKINS replied  that an outside loan  could be obtained,                                                               
but it's something most dealerships don't like to do.                                                                           
SENATOR COWDERY asked  whether the change [proposed  in the bill]                                                               
is for convenience or is cost-driven.                                                                                           
SENATOR THERRIAULT arrived at 1:46:13 PM.                                                                                     
SENATOR  SEEKINS answered  that it  is more  to bring  acceptance                                                               
companies  under the  same types  of regulations  and disclosures                                                               
that  the federal  government  has,  thereby allowing  acceptance                                                               
companies to compete with banks on an equal footing.                                                                            
SENATOR COWDERY  asked if  the Department  of Law  (DOL) supports                                                               
this bill.                                                                                                                      
SENATOR  SEEKINS said  he didn't  believe [DOL]  had been  asked.                                                               
However, states commonly try to  bring their laws into compliance                                                               
[with federal laws], and most  states' laws are now in compliance                                                               
with  Regulations  M  and  Z.   He  added  that  [the  bill]  was                                                               
requested by the acceptance companies.                                                                                          
SENATOR  COWDERY offered  his belief  that  the attorney  general                                                               
wanted to testify on the bill, but wasn't available.                                                                            
CHAIR HUGGINS suggested hearing from him at a later date.                                                                       
SENATOR SEEKINS  indicated the attorney general  hadn't expressed                                                               
an opinion to his office.   In response to Chair Huggins, Senator                                                               
Seekins said  he hadn't heard  negative feedback from any  of the                                                               
finance institutions.                                                                                                           
CHAIR HUGGINS asked about pros and cons for the customers.                                                                      
SENATOR SEEKINS answered that the  loan would still be made based                                                               
on the  customer's ability to pay.   Generally, a loan  for a car                                                               
is  an accommodation,  trying to  help the  customer buy  the car                                                               
that he or she wants.   He said most dealers can handle contracts                                                               
through banks,  and this brings  it down  to a matter  of equity.                                                               
There may  be $1,000 additional  cash for people  working through                                                               
Ford Motor Credit, for example,  but if there is negative equity,                                                               
the dealership  cannot help the  customer take advantage  of that                                                               
under state law now.                                                                                                            
CHAIR HUGGINS  posed a situation  in which a customer  has $5,000                                                               
in  negative  equity.   He  asked  what  allows a  dealership  to                                                               
leverage that to a customer's advantage.                                                                                        
1:50:24 PM                                                                                                                    
SENATOR  SEEKINS noted  that  in the  past,  negative equity  was                                                               
adjusted in  the paperwork.   Now the situation is  disclosed and                                                               
yet    it's    financed    anyhow,   because    the    customer's                                                               
creditworthiness  allows  making  those [larger]  payments.    In                                                               
response to  Chair Huggins and  Senator French, he  affirmed that                                                               
currently it can be rolled over  into new financing - but through                                                               
banks or credit unions, not acceptance corporations.                                                                            
SENATOR FRENCH  voiced concern about  people living  beyond their                                                               
means, and  reported reading in  Forbes that the savings  rate in                                                             
the U.S.  just went negative for  the first time since  1933.  He                                                               
said, however, this  bill is more a symptom than  a cause, and he                                                               
sees no reason to harm institutions doing business in Alaska.                                                                   
He expressed  interest in seeing  Regulations M  and Z.   He also                                                               
requested a  handout that shows  how the paperwork could  be done                                                               
under the federal system, but not the state system.                                                                             
1:52:50 PM                                                                                                                    
SENATOR   SEEKINS   indicated    he'd   provide   the   requested                                                               
SENATOR COWDERY asked whether [a dealer]  can make a cash loan to                                                               
an individual.                                                                                                                  
SENATOR  SEEKINS  answered  that  he  could,  but  doesn't.    He                                                               
explained, "Part of our agreement  with most finance institutions                                                               
is, we  don't loan money  as part of  their down payment.  ... We                                                               
disclose it as what  it is."  He said on  a lease transaction, if                                                               
not properly  disclosed, the  negative equity  could be  termed -                                                               
without the definition  in Regulation M - as a  personal loan and                                                               
then  not   be  properly  disclosed.     Therefore,  the  federal                                                               
government  changed   its  process  of  disclosure   in  a  lease                                                               
transaction so that it is not a personal loan.                                                                                  
He  pointed out  that  for every  loan on  a  vehicle, there's  a                                                               
decision that  the finance  institution makes:   Does  the person                                                               
have  enough disposable  income to  make those  monthly payments?                                                               
If so, and  if the person has  a good credit history,  there is a                                                               
willingness  to  finance  an  "upside  down"  or  negative-equity                                                               
situation.  It  isn't considered a personal loan, and  is still a                                                               
transaction on the car.                                                                                                         
1:54:33 PM                                                                                                                    
SENATOR COWDERY observed that it seems like a personal loan.                                                                    
SENATOR  SEEKINS said  many  cars have  negative  equity for  the                                                               
first  two or  three years  after purchase.   He  noted that  so-                                                               
called gap  insurance is sold in  the marketplace today:   if the                                                               
vehicle is totaled,  the loan is paid off, even  though the car's                                                               
value doesn't equal what is owed.                                                                                               
1:55:53 PM                                                                                                                    
CHAIR  HUGGINS asked  what a  dealer  could do  for someone  with                                                               
$5,000 in negative equity.                                                                                                      
SENATOR SEEKINS  explained that  there are three  ways to  help a                                                               
customer "get  out of that car":   cash, having enough  margin in                                                               
the new vehicle  to make up most  or all of it,  or financing the                                                               
negative equity.   First, as the dealer he'd  determine the car's                                                               
actual  cash  value  -  wholesale  value  -  to  him;  he'd  also                                                               
determine what  is owed.  If  there's a $5,000 gap,  but a $3,000                                                               
"markup in  the car," he may  allow $1,500 of that  markup "to go                                                               
back into the vehicle."  This leaves  only a $1,500 gap.  At that                                                               
point,  if the  customer is  creditworthy, the  dealer might  not                                                               
request more of a down payment,  or else the customer might pay a                                                               
$1,500 down payment.  That would  put the customer at 100 percent                                                               
financing on the new vehicle.                                                                                                   
He  noted that  if  the  dealer can  find  a finance  institution                                                               
willing to finance  $1,500 more than it  otherwise would, because                                                               
of  the customer's  creditworthiness,  then the  dealer  - if  he                                                               
properly discloses it  - can have that  negative equity financed,                                                               
provided it's through a bank or credit union, under federal law.                                                                
1:57:36 PM                                                                                                                    
SENATOR  SEEKINS, in  response  to Chair  Huggins,  said all  the                                                               
options are available to a dealer.   All he's doing [with SB 300]                                                               
is   bringing  the   acceptance  corporations   under  the   same                                                               
regulations as the  federal banks and credit unions.   However, a                                                               
customer may  end up  paying more  in interest,  or might  not be                                                               
able to  get a bonus  incentive from the  acceptance corporation.                                                               
In some  cases, incentives  from acceptance  corporations provide                                                               
an additional  $1,000 that the  customer could apply to  the down                                                               
payment, he  noted.  Having it  equal in terms of  disclosure can                                                               
sometimes be a benefit for the buyer, he suggested.                                                                             
1:59:47 PM                                                                                                                    
BRIAN  HOVE,  Staff  to  Senator   Ralph  Seekins,  Alaska  State                                                               
Legislature, offered to answer  questions during Senator Seekins'                                                               
brief absence.                                                                                                                  
SENATOR  COWDERY  asked, in  essence,  whether  the interest  for                                                               
financing a $5,000 equity gap would  be the same as the financing                                                               
for a new car.                                                                                                                  
MR.  HOVE answered  that  it's the  same  contract. The  customer                                                               
would be  paying off the old  contract and rolling it  into a new                                                               
one -  a single contract  with one  set of terms  and conditions,                                                               
including interest.                                                                                                             
2:00:47 PM                                                                                                                    
CHAIR  HUGGINS recalled  there are  variables,  however, and  the                                                               
institution could change the interest rate, for example.                                                                        
MR. HOVE  answered that  it comes down  to expanding  options for                                                               
the buyer  with regard to  financing sources.  He  suggested this                                                               
offers  the buyer  an opportunity  to  get a  better deal,  since                                                               
acceptance corporations aren't included currently.                                                                              
2:02:05 PM                                                                                                                    
SENATOR  SEEKINS added  that this  came  as a  request from  "the                                                               
legal department."  He said  several acceptance corporations want                                                               
this clarified so that they're  clearly on an equal footing [with                                                               
banks and credit unions].                                                                                                       
CHAIR HUGGINS  advised that  he'd see  about the  availability of                                                               
the attorney general [to testify  at the next hearing], and would                                                               
determine  whether  banking  institutions  want  to  offer  their                                                               
perspective as well.                                                                                                            
SENATOR  FRENCH indicated  when the  attorney general  is present                                                               
he'd like to hear whether this  is a good idea and perhaps should                                                               
be done for home sales as well.                                                                                                 
2:02:43 PM                                                                                                                    
CHAIR  HUGGINS pointed  out that  homes normally  appreciate over                                                               
time, whereas automobiles depreciate rapidly.                                                                                   
SENATOR SEEKINS  reiterated his intent  to put all  those finance                                                               
institutions on  an equal  footing in  terms of  full disclosure.                                                               
[SB 300 was held over.]                                                                                                         

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