Today’s uneven auto finance credit performance is wholly acceptable, as long as the underlying underwriting is not being eroded, as it was in the mortgage industry in the time leading up to the credit crisis.
There simply is no evidence of systemically significant erosion in underwriting standards in auto finance — despite The New York Times‘s carping.
In 2013, subprime auto LTVs were higher while average loan rates declined — even as cost of funds remained constant, according to the NAF Association’s recently released 2014 Non-Prime Automotive Financing Survey. Just to explain so everyone is clear: Higher LTVs imply, but only imply, less-stringent underwriting, because the higher the LTV, the greater the leverage on the asset. However, lower average loan rates imply less risk, because the loan is presumably more affordable to the consumer. Obviously, these are, by far, not the only underwriting criteria that matter, however they are indicators. So, getting back to the higher LTVs — on used loans, the increase last year was 2.1%, and on new-car loans, LTVs were 1.9% higher. Is 1.9% or 2.1% significant? That’s a question for the quantitative analysts.
An investigation of more current data found that, in fact, it is difficult to argue that underwriting standards have further eroded this year. While aggregate data is hard to come by, underwriting for some individual lenders can be illustrative. Let’s consider CarFinance Capital, which is a West Coast subprime lender that does about a third of its business directly with consumers, rather than through dealers. CarFinance, which is owned by Perella Weinberg, an investment fund created by Joe Perella, the famed former head of M&A at Morgan Stanley, was bringing a securitization to market last week. The securitization’s July 24 pre-sale report from S&P indicated that the LTV in CarFinance’s portfolio is lower; its average Fico is up; its debt-to-income ratio is down; and its payment-to-income ratio is lower. The PTI in CarFinance’s 2Q underwriting was 10.1%. In NAF’s report, the industry average increased in 2013 to 12.6% from 12.5% in 2012. CarFinance, at least, does not appear to personify a lender eroding its underwriting to make more loans, even though CarFinance’s YOY originations are 88% higher and it operates in the highly competitive West Coast market.
Regardless of the debate on what constitutes a significant erosion of underwriting standards, it misses a key distinction: The auto finance industry is not the mortgage industry. Auto finance products are unique in that they possess a short, de-levering structure. Even those LTVs we have talked about are measured against 90% of the MSRP or purchase price, not 100%. That’s because the depreciation is baked into the financing right from the get-go.
This is the second in a series of posts on the state of auto finance today.
