Longer Loan Terms Could Artificially Drive Demand

Extended terms and low rates may be artificially inflating demand for automobiles, according to analysts.

Interest rates on home mortgages have risen slightly since 2013 and a corresponding increase in auto finance rates could slow sales growth for the remainder of 2014, according to a September 8 report from Standard & Poor’s corporate ratings group.

That makes sense, since the group also says in the same report  that they believe low financing rates and extended financing terms have played a key role in the higher transaction prices over the past year or two.

Rate increases have not yet occurred in auto, but are predicted.

S&P said longer term loans, specifically those over 72 months, continue to dominate the market. Nonetheless, loan delinquencies are near historical lows.  Still, S&P believes there are some emerging signs of risk in auto lending, based on lenders’ willingness to stretch terms over 72 months and use higher residual value assumptions to attract borrowers with lower credit scores, and offering loans that exceed the value of the car.

That said, at an S&P event in New York on Sept. 9th, analysts reiterated that all sectors of the auto finance space were seeing growth in both prime and subprime lending and in the auto ABS market.

Amy Martin, senior director at S&P Ratings auto ABS group said subprime lenders have also been utilizing their own proprietary credit scoring models and Fico scores are not the only gauge of borrower creditworthiness. S&P is seeing losses rise, Martin said, but those are climbing up from historically low levels. In fact, she stressed that 2012 and 2013 subprime auto loan securitization vintages have lower losses than those from 2006 -2008. In other words, the ABS space is seeing good collateral loss performance despite some degradation in pool credit quality.

But Martin also raised some concern over lengthening loan terms.

“This year marks the first time we’ve seen loan terms of 73 to 75 months represent 10% or more of a subprime pool,” she said, “and this concerns us because we believe that longer term loans, have higher severity of loss upon a repossession. And we’re also looking to see if those higher losses associated with longer term loans would be exacerbated by higher LTVs too, and that gets to layering of risks, if these longer term loans are also coming with higher LTVs.”

Despite those historically low delinquencies, the S&P corporate group said in its Sept. 8th report that there could be some emerging signs of risk based on lender’s willingness to offer longer loan terms based on an assumption of higher residual value.

And therein comes a word of caution.

The Sept. 8 report says that if the longer terms trend does continue, it could be pulling ahead of future demand, and as a result, S&P does not expect a meaningful rise in auto sales in 2015. S&P believes the recent subpoena served to GM’s captive, GM Financial, indicates regulators’ concerns and potential risks related to the quality of subprime loans, according to the report.

Over the long term, the potential for rising interest rates, relatively weak job growth, improved life of cars, declining used car prices, and a decline in driving patterns among millennials, remain risks, according to S&P forecasts.