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.
Agreed,
Even the recent reports about GM and Santander have to do with their mortgage side, not their auto finance side.
As we have seen from the CFPB, the auto credit industry and auto dealers have many ” eyes” watching where the mortgage industry in the late 2000’s were not watched at all.
Good article JJ, thank you for sharing this great information, and it appears the sub-prime auto loan industry is being lumped in with the sub-prime mortgage debacle again, only due to the fact that our customers share low credit scores.
I’d like to add some other significant differences also exist between these portfolios that will keep the auto loan”bust” from happening:
• Better Collateral Valuation – the vehicle lenders always have and will continue to base their Loan to Value amounts based on Vehicle Manufacturer Costs (with steady average increases of 3-5% annually) and never on Appraised Values, subject to volatile market conditions, for assets that depreciate in relatively steady and proven values.
– Consistent Risk Based Pricing – automotive lenders have been consistent with application of Risk Based Pricing, obtaining much higher rates and yields from subprime customers to offset increased losses should they occur. The mortgage lenders were offering too low teaser rates to their subprime customers, therefore had no margin to cover increased losses, putting AIG into default on their portfolios.
• Shorter Asset Terms with Fixed Interest Rates – Vehicle loans average 5 years with fixed interest rates versus 15 to 30 year mortgages, many with 5yr ARMS. By knowing what the customer’s fixed payment will be for the entire loan term, automotive lenders have a much higher confidence rate with their customers’ ability to make their payments by limiting their Payment to Income ratios, which only improve over time as most clients’ income increase. By placing any customer at their maximum Payment to Income ratio, sub-prime and prime, in a variable rate large loan amount where the payments will increase a minimum of $300 to $500 per month in a historically loan interest rate environment and know rates are only going to increase, is a recipe for default disaster.
• Lack of Alternate Choices – When home owners have to make a decision on defaulting on their mortgages, they can find alternatives by renting apartments or homes, which makes their life decisions easier than the same decision on their vehicles. The only alternatives to owning their vehicle is public transportation, taxi cabs, or bicycles, which makes their lives much more difficult.
• Dramatically Increased Asset Liquidity – Due to the thousands of automotive auctions nationally, vehicles can be liquidated in less than 15 days, versus average sale time of a home of 6 to 12 months, thereby decreasing the loss severity due to depreciation and wear/tear.
• Larger required Initial Investments in Asset – Automotive Lenders have always required an average of 10% Down Payment when financing vehicles, where FHA and other mortgage programs have only required as little as 2% down payment, which is a large consideration when a customer has to make a decision to default on their loan and lose their asset.
Great points, both. Thanks.
I’ll be posting more on this subject next week.
I think the truth is somewhere in the middle. Yes, loan performance for prime auto loans is very strong. Yes, charge-offs for sub-prime are still way below 2009, but that sector has grown very quickly over the last couple of years and losses should not be climbing quite that quickly. Yes, sub-prime is at its highest level since pre-financial crisis. However, much of that sub-prime has been booked on used cars sold at record high prices. As new car sales continue to increase, demand for used cars will slowly decline and so will values. These older, higher mileage used cars sold to sub-prime borrowers will eventually break down and break down sooner in the life of the loan. Once the lender gets the car back, their net realized value will be lower than in years past. Much higher losses will occur.
Listen, I don’t think this is a disaster waiting to happen, but simply the signs that there will be a downturn in sub-prime auto, which will cause these lenders to slash and burn like they have on every sector and financial downturn over the last 25 years. Sub-prime requires patience, disciplline in pricing and underwriting, and the financial strength to weather the bad years without having to shut down lending and focus on collections.
The sub prime sector has grown because many consumers had their credit score maimed during the Great Recession. BHPH and sub prime, both parts of the same segment, are a good way for consumers to rehabilitate their credit score. Since households suddenly lost 38% of their net worth due to the GR. and mortgage defaults and unemployment destroyed a lot of prime credit scores, lenders and dealers have rushed in to fill the void. I know many dealers who pull their customers out after 18 months and put them into a better vehicle through a near prime lender program after their score has been somewhat repaired. I think that’s a pretty good thing.
There is no auto finance bubble, period. And the SAAR still has a ways to go. We lost millions of new vehicle sales and population has increased since 2008/2009. Many new vehicle buyers are struggling to get back to being able to buy one. This ride has a ways to go.
Yes, the Fed will gradually increase interest rates, as well they should. They will do it slowly. The captives will step in with subventions and OEMs will provide rebates and other incentives so independent lenders can play the subvention game.
Like many of you leaving comments, I have been in the sub-prime auto finance business for many years. We always see movement in the market, one way or the other. The movement in the market today is like none we have seen since 2006. What we Lenders need to do is ride the wave, but not ever deviate from our underwriting standards for the sake of increased volume. That’s what some of the auto finance companies mentioned by J.J. in his article have done or they would not be experiencing the numbers mentioned. We all need to stand firm on credit quality or the sub-prime auto finance industry will turn into another mortgage industry like fiasco.