The Phaserl


Subprime Auto Loans Crushed Worse than in 2009, Auto Industry Bleeds, Knock-on Effects Commence

by Wolf Richter, Wolf Street:

After the credit bubble comes the credit bust.

Subprime auto loans, a big force behind booming car sales in recent years, are getting crushed by defaults, particularly those originated between 2013 and 2015 when the proportion of subprime loans began to surge while underwriting standards became loosey-goosey, as private-equity-backed auto finance companies with a ravenous appetite for risk, subprime, and securitization elbowed into the market, amid the exuberance of the greatest credit bubble in history.

“Bad deals are made in good times,” says the old banking saw.

Auto lenders package their loans into asset-backed securities (ABS) and sell them as bonds to yield-hungry institutional investors. Fitch Ratings, which rates auto lenders and auto-loan ABS, just reported on the state of the industry.

The Fitch Auto ABS Indices show that 60+ day delinquencies were relatively low for prime auto loans at the end of Q4, but for subprime loans they’ve surged to 5% of outstanding balances, the highest since at least 2008, during the depth of the Financial Crisis!

Net charge-offs show a similar scenario, only worse. Net Charge-offs from prime loans ticked up to a still low 0.75% of outstanding balances. But net charge-offs from subprime loans surged to 10.5%, the highest since at least 2008!

Subprime is “particularly vulnerable,” Fitch says. It expects credit performance to deteriorate further.

Simultaneously, another trend is biting lenders and investors in subprime auto loan ABS: While for the overall market, average loan terms have reached a record 67 months, for subprime borrowers they’ve jumped to over 72 months.

Fitch adds icily:

[T]he data conflict with commentary from several large auto lenders that have suggested the loan term extensions in recent years have been primarily targeted at prime borrowers.

No one wants to accuse the industry of lying to investors about risks. But this is pretty close.

And it’s important. Longer loan terms make payments more affordable for cash-strapped consumers. Thus they pump up sales volume. And they allow finance companies and dealers to make higher profits. As underwriting standards got very loosey-goosey starting in 2013, loan terms (along with loan-to-value ratios) wandered off into new territory.

But as loan terms lengthen, depreciation of the vehicle outruns the amortization of the loan principal for longer, and borrowers have negative equity for longer, which raises the risk of loss, particularly for subprime loans. Fitch:

This will pressure recovery values on defaulted loans and also hurt customer trade-in values, which could negatively affect future new car sales/financings.

Why is this important for the industry as a whole, not just lenders and their investors?

Lenders are starting to feel the bite of those losses that are made worse by extended loan terms, higher loan-to-value ratios, a higher proportion of subprime loans, more negative equity for longer, and hence subprime defaults and net charge-offs that are soaring to crisis levels.

This spiral is made worse by dropping wholesale prices of used vehicles when they’re sold at auction, which is where lenders unload repossessed vehicles.

To tamp down on future losses, lenders began tightening underwriting standards, particularly in the subprime segment, in 2016. Fitch cited the Federal Reserve’s January 2017 senior loan officer survey:

In the survey, pricing, minimum down payment and minimum credit were all tightened by respondents on a net basis, although the maximum loan maturity continued to lengthen.

So at this point, despite tightening in some areas, lenders continue to lengthen loan terms. Why? Because shortening terms, in face of high prices, and hence unaffordable payments for stretched consumers, would strangle sales volume and profits. But they are getting nervous.

The overall tightening of underwriting standards is consistent with comments made by several banks on earnings conference calls over the past couple of quarters. Fitch believes the tightening of underwriting standards is a response to expected deterioration in used vehicle prices and the weaker credit performance experienced in the subprime segment.

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