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Top 6 Reasons Some Fear the Next ‘Big Short’ in Subprime Auto

Diana AsatryanbyDiana Asatryan
April 8, 2016
in Best Practices
Reading Time: 4 mins read
0

canstockphoto5627881LAS VEGAS — The Big Short, the tale about the investors that made bank predicting the mortgage crisis in 2008, left many wondering whether a real-life “sequel” is unfolding right now in the subprime auto finance space.

The fears of a subprime bubble certainly did not appear out of thin air. Experts highlighted the reasons for the recent claims that the Next Big Short is coming to subprime uuto during a panel at the recent Vehicle Finance Conference.

Hyped Up Media Reports

“There’s a lot of articles from the New York Times, comparing subprime auto to mortgage,” said Andrew Stuart, president and chief executive of TD Auto Finance, LLC. “But for everybody that’s in the industry and takes a deeper look at this: the Big Short story is a story about securitizations that had no value, and in the auto space we don’t have securitizations that have no value,” Stuart explained.

Loosening of Credit Criteria

Even though softer credit criteria is “good money” for dealers today, in the long term, those loans are more likely to default, said Joe Castle, dealer principal at Castle Auto Group. “I am seeing some of my lenders that are waving stipulations at 550 credit scores and that scares me,” he said during the panel. “I love the money now, but I told my guys ‘Let’s not push this, and not oversell on this.’ We can’t be greedy.”

There is a lot happening “behind the scenes,” when it comes to underwriting processes that help to keep risks low, said Mike Urrutia, senior vice president of dealer services at General Motors Financial Co. “There is a whole lot of new technology involved there in terms of various products,” he said.

Moody’s Investor Services released a report on Wednesday, suggesting that net loss rates are increasing in the subprime-backed ABS sector. “Much of the overall performance deterioration is a result of an increased number of ABS transactions from smaller lenders that cater to ‘deep’ subprime borrowers who have particularly weak credit,” according to the report.

Heightened Competition

New entrants and loosening of credit requirements also result in heightened competition in the industry, said Elizabeth Webb, executive vice president at Exeter Finance Corp. “This causes some lenders to maybe be more aggressive in their offerings,” she said on the panel. “But default rates are super low, and people are actually making their car payments. There is always competition, we just need more control over this.”

Origination Growth

The number of lenders issuing auto ABS has increased to 19, up from the previous high of 14 in 2005 and 2006, also contributing to the weaker performance, according to a recent Fitch report.

“Subprime ABS issuance averaged just over $20 billion in 2013 and 2014 before ballooning to over $25 billion in 2015, the highest level since 2005-2006,” Fitch said in the report. “Sharp origination growth, increased competition and weaker underwriting standards over the past three years have all contributed to the weaker performance [subprime ABS] of the past year.”

Used Car Values and Supply

“There is a good supply of cars out there that you could buy, the business is great,” Forrest McConnell president and McConnell Honda & Acura said at the panel. “But the car business is changing, it’s hard to say what’s going to happen.” The dealer group is “focused” on staying diligent on overhead expenses, and capitalizing profit, McConnel said.

On the finance said, Exeter’s Webb said, the focus is to place customers in cars that they can afford. “I don’t think softening of values will be anything huge or overly dramatic,” she said.

Ally Financial Inc. said it was “comfortable” in the used car space during its earnings call in February. “When we originate on used cars, the predictability of value is pretty consistent, whereas the drop is much bigger on the new cars, and it’s harder to predict,” Chief Financial Officer Chris Halmy said during the earnings call. Halmy added that the expected drop in used car prices will not drive significant losses within Ally’s portfolio.

On the supply side, the prospective is “a little more negative” than most industry players expect, Ian Anderson, group president of Westlake Financial Services, said during a separate panel at the Vehicle Finance Conference. “We own a rental car company, so we have some insight into fleet business,” he said. “Off-lease vehicles will be coming in, in addition to repossessions really hitting hard in the third or fourth quarter this year, so we’ll have more supply there.” Those factors will directly affect the vehicle values, Anderson added.

Tags: Honda
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