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 information. 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.]