Untangling uncertainty: Subprime lenders, borrowers navigate affordability

These are uncertain times for the auto finance market, especially for subprime consumers and lenders. The affordability of capital and cars is shrinking; vehicle prices, interest rates and the cost of funds are rising; and consumer credit performance is worsening. Elevated vehicle prices and higher monthly payments have contributed to affordability woes and have pushed some subprime consumers out of the market over the past two years, resulting in a decline in subprime and deep subprime market share. Subprime auto loan and lease financing accounted for 15.6% of all auto finance originations in the fourth quarter of 2022, a decrease of 81 basis points (bps) compared with Q4 2021, according to Experian ’s State of the Automotive Finance Market Q4 2022 report. Subprime originations accounted for 13.7% in Q4 2022, while deep subprime accounted for 1.87%. The decline in subprime market share has been a notable trend since before the pandemic, Melinda Zabritski , senior director of automotive financial solutions at Experian, told Auto Finance News. “We’re still seeing originations at lower levels in [subprime] than we saw pre-COVID. It’s going to take some of the prices to come down and the vehicle values to come down in order to see that portion of the population begin to grow again.” Subprime loan originations totaled 2.8 million contracts in 2022, a decrease of 15.1% year over year, according to Experian. In pre-pandemic 2019, subprime originations totaled 4.4 million loans. “When we look at overall consumer credit, we’ve seen that there are fewer consumers that are falling into the subprime categories,” Zabritski said. “We have seen a score migration of consumer credit scores continuing to increase.” The subprime market accounted for 14.5% of outstanding loan balances — or $204.9 million — up 210 bps in Q4 2022 as outstandings rose in tandem with average loan balances, according to Experian. The average amount financed on new vehicles reached $41,445 in Q4, an increase of 4.04% YoY, while the average used-vehicle loan amount increased 1.4% YoY to $27,768 in Q4, according to Experian. Some subprime lenders increased originations YoY Still, some subprime lenders have been able to carve out YoY increases in originations. Consumer Portfolio Services (CPS) and Credit Acceptance Corp. (CAC) both showed increases in originations in Q4 2022 despite an overall dip in subprime market share. CPS’ originations jumped 30.5% YoY to $28.1 million in Q4 2022, while outstandings totaled $2.8 billion, up 26.5% YoY, according to the company’s Q4 earnings release. “Our total managed portfolio eclipsed $3 billion for the first time, and our earnings for the year are the highest ever in our history,” CPS Chief Executive Charles Bradley said during the earnings call. Southfield, Mich.-based CAC’s consumer loan assignment volume also increased , rising 25.6% YoY on a unit volume basis to 62,074, according to the lender’s Q4 2022 earnings report. Outstandings ticked down 2% YoY to $9.2 billion despite the increase in consumer loan assignments. Deep subprime lender Nicholas Financial did not fare as favorably, posting a $13.4 million net loss for the quarter ending Dec. 31, 2022. Losses increased by more than $12.6 million YoY, compared with a loss of $702,000 in the same reporting period in 2021, according to the company’s earnings release. Nicholas Financial’s originations clocked in at $1.1 million for the quarter ending Dec. 31, 2022, a decline of 83.5% sequentially and 87.3% YoY. Lender pullback amid market volatility Some subprime lenders have pulled back on auto loan originations amid concerns regarding consumer credit health, tighter margins and limited accessibility to capital markets. Nicholas Financial, for one, exited its direct lending business despite posting double- and triple-digit growth quarter after quarter and changed to a regionalized business model in the second half of 2022. “We’ve seen a lot of competitors pulling back,” Landon Starr , chief risk and information officer at subprime lender Arivo Acceptance , told AFN . “We see a lot of traditionally high-volume lenders and others that we see in the marketplace more often not as present anymore.” Irvine, Calif.-based CPS began to slow growth to maintain margins amid rising costs of funds and inflation following strong growth in the first six months of 2022 , Bradley said on the Q4 earnings call. CPS tightened credit in Q4 to maintain margins amid increased cost of funds. The lender’s APR rose to 21% at the end of 2022 compared to 15.99% in February 2022, Mike Lavin , president, chief operating officer and chief legal officer at CPS, said on the lender’s Q4 earnings call . Increased cost of funds, compressed margins, concerns over consumer credit quality and the potential for increased losses are factoring into lenders pulling back, Arivo’s Starr said. “Those dynamics coupled with a relative instability of the asset-backed securities (ABS) market, where it’s more difficult to get investors to invest in certain tranches, has led to liquidity issues for some [lenders],” Starr said. “We’re hearing in the securitization market that it’s difficult to get deals closed. [Lenders] are not seeing as much subscription or investment in the securitization deals.” Most subprime issuers were able to get into market during the last two weeks of January and first two weeks of February as spreads tightened following year-end lulls spurred by widening spreads. Momentum through March has slowed, however, as spreads widened back near levels similar to the end of 2022. In the four weeks from Jan. 18 to Feb. 15, there were 13 subprime auto ABS issuances, according to Finsight , which monitors securitizations. By comparison, there were six issuances in March. Subprime lenders Automotive Credit Corp. , Drivetime , First Help Financial , First Investor Financial Services and Veros Credit have yet to securitize in 2023. In fact, volatile spreads forced Santander Consumer USA to pull its second subprime ABS issuance of the year — a planned $942 million deal — off the market on March 15. Santander’s first deal was an $810 million issuance, which closed on Jan. 18. Santander pulling back its deal does not necessarily paint a bad picture for the lender, Eugene Belostotsky , director and head of Citi Research ’s US ABS strategy team, told AFN . “I think it shows them having flexibility and not needing to do a deal immediately because they have other sources of funding,” he said. Even so, the forecast for subprime ABS is uncertain — even a little grim — Belostotsky said. “It’s tough to go to the money. I think the only issues that are going to the market now are the ones who need to go. … The market is waiting, or hoping, for this latest uncertainty to die down and go back to thinking about the fundamentals, the losses and underwriting.” Lack of affordability for consumers Borrowers, too, are feeling their purse strings tightening. Larger loan amounts, climbing monthly payments and increasing interest rates are making it more difficult for the already challenged subprime consumer to afford a vehicle in the current climate. “The consumer is heavily pinched on affordability right now,” Arivo’s Starr said. “They’ve already been struggling with inflation. Now, they're looking at elevated interest rates with not a ton of reprieve on inflation.” In fact, the average amount financed on new-vehicle purchases reached $41,445 in Q4 2022, an increase of 4% YoY, while the amount financed on used vehicles inched up 1.4% YoY to $27,768, according to Experian. The growth in new-vehicle loan amounts was due to short inventory, high demand and dealer markups, while the uptick in used-vehicle prices was driven by high auction demand, Experian’s Zabritski said. Monthly payments and term lengths also grew in Q4 in tandem with increased loan amounts and high interest rates. The average monthly loan payment on new vehicles for deep subprime consumers was $700 while subprime consumers paid an average of $746, an increase of 11.6% and 11.8% YoY, respectively, according to Experian. Loan terms, on the other hand, have done little to quell monthly payment pressures. Term lengths on new vehicles for deep subprime borrowers averaged 73.01 months, an increase of 0.67 months YoY, and subprime averaged 74.02 months, an increase of 0.32 months YoY. The monthly used payment sat at $524 for deep subprime consumers and $542 for subprime consumers, increasing 5.7% and 6.7% YoY, respectively, according to Experian. Used-vehicle financing term lengths for deep subprime grew 1.54 months to 62.95 months and subprime term lengths increased by 1.1 months to 66.58 months. Still, subprime consumers’ demand for vehicles remains strong even as loan amounts and monthly payments have risen, Arivo’s Starr said, noting that the West Valley City, Utah-based lender has seen an increase in credit application volume and foot traffic at the lender’s dealer partners. “In the auto lending market, particularly subprime, this is kind of the peak season,” he said. “We’re in the heart of consumers getting tax returns. This is generally one of the higher consumer demand times of the year.” Credit is less available at dealerships, too. Availability in January contracted to the tightest it’s been since June 2021 , according to Cox Automotive’s January DealerTrack Credit Availability Index. Access to credit was tighter by 3.9% YoY. “There are a lot of pressures and a lot of complexities that kind of muddy [the seasonality] a little bit,” Starr noted. “The ongoing upward pressure on interest rates, the reduced credit availability because some lenders are pulling back, those kinds of dynamics are making the environment less conducive towards credit access and great pricing [for consumers].” Rising delinquencies Sixty-day delinquencies industrywide have reached historic highs in the subprime credit tier and in aggregate , according to Cox Automotive . Subprime loans that are 60-plus days past due reached a record high of 7.3% as of February, according to the Cox’s Q1 industry insights call. Across the entire credit spectrum, 60-day delinquencies rose to 1.9% in the first quarter, relative to the outstanding loan base, according to Cox. Despite rising delinquencies, the default rate has not grown at the same pace, Jonathan Smoke , chief economist at Cox, said, noting that defaults have not jumped as much due to the loan pool being higher quality and consumers prioritizing auto loan payments. The overall default rate reached 2.78% in February, still below February 2019’s rate of 3.2%, he said. At CPS, delinquencies 30-plus days past due reached 11.1% in Q4 2022, up 162 bps YoY, according to the company’s Q4 earnings release. Net charge-offs rose 90 bps sequentially and 326 bps YoY, totaling 5.83% of the lender’s portfolio in Q4 2022. CAC, too, saw a decline in forecasted collection rates. Loans assigned in 2020 were forecasted at 67.8%, a decline of 20 bps sequentially, and rates on loans assigned in 2021 were forecasted at 66.2%, a decrease of 60 bps compared with Q3, according to the earnings report. Forecasted collection rates on loans assigned in 2022 came in at 66.3%, a decline of 20 bps sequentially. CAC also increased its provision for credit losses as forecasted collection rates declined. Provisions rose by 403.1% YoY to $130.3 million in Q4 due to loan performance, according to the company’s earnings report. Time will tell Arivo Acceptance, however, continues to see delinquency levels , that are “really low relative to the marketplace,” Starr said, declining to provide specific figures. “We've definitely seen significant spikes across the entire subprime landscape. We haven't been completely immune to those spikes, so we're seeing similar rates of change that are kind of organic as it relates to the state of the economy.” Loans pooled in Arivo’s April 2022-1 securitization had a total delinquency rate of 5.8% for the December collections period, according to DBS Morning Star, while loans pooled in the lender’s October 2019-1 securitization had a total delinquency rate of 8.1% during the same period. Nonprime loans securitized on the wider ABS market fared better than the wider industry, according to Kroll Bond Rating Agency ’s February auto loan ABS index. KBRA’s non-prime loan ABS index includes credit performance data from all outstanding non-prime securitized auto loan collateral pools that carry a rating, according to the company. Nonprime loans 30 to 59 days past due ticked down 63 bps month over month to 8.56%, according to KBRA. Delinquencies 60-plus days past due declined 14 bps MoM to 5.74%, boosted by tax refunds. With markets still unpredictable, only time will tell how it all shakes out, Arivo’s Starr said. “There’s a new surprise every week and being able to ingest all this incoming information continues to paint new and different pictures and new strategies of how best to move forward,” Starr said. “There’s no shortage of excitement right now in the subprime lending environment,” he said. “It ’ s got everybody paying a lot of attention and listening closely to the voice of consumer perspectives, but also listening closely to the market." Auto Finance Summit East, Auto Finance News’ new spring event, is set for May 10-12 at the JW Marriott Nashville featuring a fireside chat with Peter Muriungi , CEO of Chase Auto . Visit autofinance.live.

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