That was the message from a report issued yesterday by Standard & Poor’s, which indicated that the path lenders choose will shape the rating agency’s actions for the next few years. Specifically, S&P may lower some nonbank ratings if it sees loan rates fall further and underwriting terms continue to relax, combined with accelerated lending volume.
The report ― called “After a Strong Post-Crisis Showing, Can U.S. Nonbank Auto Lenders Handle Rising Competition?” ― said the average loan rate on new vehicles has fallen to less than 4.4% from about 5% since the fourth quarter of 2010. During the same period, the average amount financed has risen to almost $27,500, while loan terms have extended to a record 64 months on average, according to data from Experian.
S&P does not expect to upgrade many nonbank auto lenders in 2014 and 2015 unless competition eases and lenders maintain their underwriting standards, the agency said.
The report’s authors said credit quality has weakened slightly in recent months, and there’s a likelihood that unsustainably high used-car prices will come down. Those factors, they said, should lead to lower risk-taking and higher lending margins.
It all boils down to the increasingly competitive landscape. More players have entered the space, drawn in by the opportunity ― not necessarily by consumer demand.
Bank senior loan officers have reported strong auto loan demand, but also good demand for prime mortgages and modest demand for credit cards, according to the Federal Reserve’s Senior Loan Officer Opinion Survey on Bank Lending Practices. S&P said banks are loosening credit standards more on auto loans than they are on credit cards or mortgages.
In the past few years, banks, captive finance companies, and nonbank specialty lenders have all jumped into the increasingly crowded pool, and all are on the hunt for auto loans. As a result, not only have yields on auto loans fallen significantly, but lenders have extended the terms of loans to unprecedented lengths, and have allowed car buyers to borrow higher balances.
Lenders have also increased their appetite for leases, an asset class that is especially vulnerable to falling used-car prices.
Standard & Poor’s said these trends could lead to higher losses and weakened profits in just a few years. Profits will surely dive if loan rates continue to fall and the strong used-car prices of the past few years decline to more normal levels.