The year of 2016 was a year of many things. It was a year in which the industry made a bid to marry auto lending and fintech. For example, Chase Auto Finance debuted a digital car-buying service, while Lending Club launched an auto refinance product.
It was a year that brought surprising election results, which could once again change the landscape of financial compliance.
It may also have been the beginning of the end of the best days the auto finance industry is likely to ever see, according to Richard Fairbank, chief executive at Capital One Auto Finance.
“The auto business, after the Great Recession, was something that I don’t think we’ll see again in our lifetime, in terms of high margins and exceptional credit quality, because so many players headed for the hills and consumers were — at times — walking away from their houses and still paying their cars,” he said during the bank’s third-quarter earnings call.
Originations Starting to Slow
By the end of October, a few of the largest auto financiers in the space were showing origination declines — some even in the double digits. The steepest drop was from Santander Consumer USA, which reported $5.2 billion of originations — a 31% year-over-year decline.
Lease originations through Chrysler Capital were down 17% YoY. Originations at SC showed improved credit quality in 3Q, which, coupled with the lower volume, is a sign of the times, Chief Executive Jason Kulas said. Loans to consumers with Ficos below 540 fell to 13% of the portfolio, from 14% last year, while loans to consumers without credit scores dropped to 12% from 15%. On a dollar basis, 3Q originations to the 540-credit-score group were $501.9 million; originations to those without credit scores were $463.3 million.
“Fewer originations are, in part, due to our disciplined underwriting standards, as we are committed to driving originations at the right price and structure, and — in part — due to increased competition in the prime space,” Kulas said. “This strategy should strengthen our overall relationship with Fiat Chrysler and our Chrysler Capital volume, as well as our serviced-for-others strategy.”
Ally Financial Inc., the second largest U.S. auto finance company in 2015, according to the 2016 Big Wheels Auto Finance report, experienced a 16% year-over-year dip in originations to $9.3 billion in the third quarter. Ally, too, is seeing a shift in its originations mix. However, the move is strategic, reflecting a risk adjustment over yield priority, according to Chief Executive Jeffery Brown.
“Yields on the retail portfolio continued to improve, as the deliberate shift to a more profitable mix continued,” he explained. This was spurred by a 36% YoY drop in nonprime originations. Nonprime assets represented 11.1% of the company’s total portfolio in 3Q, compared with 14.4% a year prior.
Ford Motor Credit Co. also reported year-over-year declines, with retail contracts down 16% to 384,000, compared with the same time a year prior. Leasing — at 89,000 in 3Q when broken out alone — was also down 16% from the previous quarter, and nearly 14% for the year, when leases were at 103,000 for 3Q15. The captive also lowered its projection on residual values, in the face of “significant” industry growth in leasing and higher new-vehicle incentives.
“As a result, our lease share and lease placement volume in the third quarter were lower compared to a year ago,” the company wrote in a 3Q presentation. “We continue to expect full-year lease share to be lower than the first quarter of 2016, reflecting the parameters of our lease strategy.”
A few banks reported an uptick in originations, most notably Capital One Auto Finance, which reported originations were up 23% YoY, to $6.8 billion. “We liked the earnings profile and resilience of the auto business we’re booking, and continue to believe that the through-the cycle economics of our auto business are attractive,” Fairbank said during the company’s call. However, despite experiencing a healthy quarter, the bank also boosted its provisions against loan losses in 3Q by 36% — $68 million — from the same time a year ago, citing its growth in auto loan originations, expectations that charge-offs would gradually rise, and declining used-car values, according to its earnings report.
Chase auto originations were up 14% year over year in 3Q to $9.3 billion, but while the bank doesn’t anticipate any immediate concerns related to charge-offs, Chase also grew its reserves in auto during the third quarter.
“We built $25 million of reserves this quarter for auto, and we expect to continue,” said Marianne Lake, JP Morgan Chase & Co.’s chief financial officer. “We think the auto opportunity is still strong, we have a great franchise, and we have great manufacturing partnerships, which are growing
Consumer Credit Starting to ‘Normalize’
Although new loan volumes slowed in the third quarter for some, the industry as a whole still experienced record growth in 2016. Auto loan balances were up 9% to $1.1 trillion by 3Q, from $1.01 trillion in 3Q15 — the previous all-time industry high, according to TransUnion.
Subprime balances experienced the largest increase, with 11.4% yearover- year growth. However, with higher balances came higher delinquencies. The delinquency rate 60-plus days past due was at 1.33% in 3Q, up from 1.19% at the same time a year prior, according to TransUnion data.
After reporting historically low losses in 2011 and 2012, most auto finance issuers started to incur higher losses on their managed portfolios in 2013, S&P wrote in a recent study. This cyclical trend continued through June 2016, and, based on heightened delinquency levels, the agency expects managed portfolio losses to rise for the remainder of 2016 and possibly 2017.
S&P found, however, that the subprime segment is showing the least deterioration. Average losses for subprime issuers increased 3% in the first half of 2016 — to 7.96%, compared with 7.71% for the same period a year prior. In 2015, average losses increased 8% — to 9.03% from 8.32% — while 2014 showed a 17% acceleration in losses to 8.33%.
On the prime side of the spectrum, losses are “normalizing,” according to S&P. For the six months ended June 2016, the average loss rates for banks, captives, and other prime lenders averaged 0.79%, from an average of 0.58% for the same period in 2015.
“Given the ease at which prime lenders can now finance their originations, in many cases using unsecured corporate debt and in the case of banks, utilizing low-cost deposits, they are once again growing their loan portfolios,” S&P wrote. “This is in contrast to the 2008 to 2010 period in which funding dried up and many finance companies severely curtailed their lending. With improved market liquidity, prime lenders have increased lending volumes by normalizing their credit standards.”
ABS Volume Stalls
Despite auto loan growth, ABS volume in particular — excluding lease and floorplan — is likely to stall through January 2017, thanks in part to Reg AB II loan level requirements, which went into effect in November, said Amy Martin, senior director of structured finance at S&P Global. The ratings agency originally projected U.S. volume would total $75 billion by yearend, however, S&P re-evaluated that number, and is projecting $66 billion of total volume, Martin said. “That’s about a 4% reduction from last year, which was $68.3 billion.” Furthermore, Santander Consumer USA and Ally Financial Inc. — two of the largest issuers — showed reduced issuance levels in 2016. As of November, SC securitized $8 billion of loans, down 26% from its total in 2015, and Ally securitized $4.95 billion, down 13% from 2015.
Through October, $93.2 billion of consumer auto loans, leases, and floorplan loans had been securitized, according to Fitch Ratings, which is expecting a yearend volume of $95 billion. “In 2014, the year ended at about $102.8 billion, and in 2015 it was similar at $102.4,” said Wendy Cohn, U.S. business head for ABS in Fitch’s Structured Finance Business and Relationship Management Group. “We’re projecting 2017 to be relatively flat to this year.”
Used Prices: What Goes Up, Must Come Down
Although some cracks have perhaps started to show for new loan volume and ABS issuance, it won’t be until 2018 that used-car values will start to drop, Charles Jones, head of dealer financial services at SunTrust Banks Inc., predicted at the 2016 Auto Finance Summit.
“The reality is that all of us, as an industry, have been wrong,” Jones told attendees at the 2016 Auto Finance Summit, referring to previous industry-wide predictions that values would have dropped by now. “I think you’ll see some easing in 2017; I don’t think it can stay as high as it’s been. But my guess is — I’ll just go out on a ledge — 2018 is probably when you’ll start to see performance plateau.”
Indeed, in the years following the recession, used-vehicle prices rose to record levels, specifically in 2011, when the Manheim Used Vehicle Value Index’s annual average was at 124.9 — the highest level recorded in the 10-year span from 1995 to 2015. In October, the Index may have dropped 0.7% to 126, but the annual average is on pace to hit 125.1 — beating the previous record.
Although the index is holding strong, Ford Credit reported in 3Q that auction values for both 24-month lease returns and 36-month lease returns — at $19,110 and $17,255, respectively — were at the company’s lowest levels since values last dipped in 4Q15. However, auction performance has been consistent with the industry when comparing similar vehicle age and segment, the captive said. Ally, too, reported that used-vehicle prices dropped somewhere between 5% to 6% YoY in 3Q, which helped grow used-auto sales to 40% of the company’s volume, compared with 35% a year ago.
Most notably, perhaps, was car rental company Hertz Global Holdings Inc.’s announcement in November that it had experienced a 14% per –unit depreciation in used-car values year over year, which had lowered the value of its fleet, the company said. The depreciation lowered per-unit car values by $304, which resulted in a $39 million hit to its estimate of the overall residual value of its car fleet.
Used-car prices were at “incredible” highs, Capital One’s Fairbank said in reference to the years immediately after the Great Recession. “The journey since has really been one of normalization,” where every year the margins have decreased and credit losses have increased. Auto losses are not “fully normalized” yet, but they have “inched up” in recent quarters, he said. “It keeps outperforming, in a good way, our own expectations of that normalization, but I think there’s a little more normalization still to happen.”