There’s No ‘Ticking Time Bomb’ in Auto Finance

Some have suggested recently that auto finance underwriting is going so sideways that the sector is standing at the very same precipice of financial calamity as did the mortgage industry in 2006. Or, as a hyped Automotive News implied Tuesday, that subprime auto finance, in particular, might be “a ticking time bomb for the U.S. economy.”

Simply put, there is no evidence of this today.

We are in the boom phase of the auto finance credit cycle. You need look at only one number for proof of that: the seasonally adjusted annual rate of new car sales in America, known in the industry as the SAAR. July saw a SAAR of 16.5 million, which is a strong, pre-crisis level of new car sales.

According to the current forecasts from IHS Automotive, a consultancy that offers one of the more reliable SAAR forecasts, new light-vehicle sales in 2014 are on track to reach 16.24 million units in North America.

The accuracy, or lack thereof, of that 16.24 million forecast is beyond the point. Rather, what is important is recognizing that a SAAR above 16 million would make 2014 a strong one for new-car sales. The auto finance sector roots out of the SAAR. As the SAAR goes, so goes auto finance. Indeed, a review of a sampling of eight auto finance companies’ performance last quarter found stellar performance. The basket of companies — Ford Credit, Ally, Santander, Fifth Third, Wells Fargo, Chase, Credit Acceptance Corp., and U.S. Bancorp — enjoyed an average of more than 2% growth in their portfolios in the quarter and greater than 12% growth rate on a year-over-year basis.

The SAAR tends to correlate to prime auto finance. To gauge the state of subprime lending, it is beneficial to consider the asset-backed securitization market, which finances a good portion of subprime auto lending. Through the first six months of the year, subprime issuance is 15% higher than it was in 2013, with $11.4 billion coming to market by midyear. S&P is projecting $20 billion this year, up from $17.8 billion last year, and $22 billion next year. These are strong numbers.

All this strong performance, however, begs this question: Is all the volume growth coming at the expense of credit performance? Overall, credit performance — and specifically auto loan charge-offs — remains within acceptable bounds. The prime side is still solid. At U.S. Bank, for example, but 0.01% of its prime portfolio of $14.1 billion of auto loans were non-performing last quarter. Not every prime lender posts U.S. Bank-like credit performance, but USB shows just how nominal prime delinquencies and chargeoffs could be.

And on the subprime side? Standard & Poor’s made some waves in the market in June with a report that said subprime auto finance performance was deteriorating. But S&P’s warning deserves a closer inspection. The report stated that the performance of the loans backing subprime auto ABS is weakening. S&P pointed out that annualized net losses on subprime auto loans increased in the first quarter of 2014 to 5.79%, up from 4.16% in the first quarter of 2013.

Is 5.79% a relatively steep increase? Yes. But it pales in comparison to the 9.39% net loss rate in 2009. There is inherent unevenness in credit performance today. A review of individual subprime lenders will find some posting “bad” or “good” results. For some lenders, Exeter is one, credit performance is trending worse than expected, but for others — First Investors is an example — cumulative net losses are better. That’s not a sign of a ticking time bomb, just of a normative market.

This is the first in a series of posts on the state of auto finance today.