Global ratings company S&P recently published an article citing leasing and nonprime that includes subprime lending as the “greatest areas of market and credit risks”. This has been shown by rising delinquencies in subprime auto loans and declining used-car prices. At the center are auto finance companies whose involvement in the above activities could result in higher losses and lower earnings.
2016 Was a Year of Rising Numbers in the Auto Industry
The year 2016 was a big one for the auto industry as characterized by a “multirise” in auto lending and leasing numbers. Citing Federal Reserve data, S&P reported the steady climb of outstanding auto loans growing at an annual rate of 8% since the end of 2010. By the end of 2016, the total outstanding auto loans reached $1.1 trillion. Auto leasing also recorded a triple growth since its trough in late 2010 to reach $226 billion.
S&P enumerated the following factors that contributed to the rise of auto loans and leases over the years.
- Low rates
- Increased lending activity to borrowers with nonprime FICO scores — those with FICO scores under 660 or 680 and labeled as near-prime, subprime or deep subprime.
- Longer loan terms
- Higher balances and loan-to-value ratios
- Relatively strong used-car prices
The ratings provider recognized that auto finance companies have to compete for new markets and this resulted in loosening their underwriting standards, accommodating borrowers with lower FICO scores, higher LTVs and balances, and longer terms.
This increased activity in auto lending and leasing has been accompanied by worsening conditions in the auto finance industry. S&P’s March 2017 Auto Loan ABS Tracker saw a rising trend in losses and delinquencies in asset backed securities that pooled subprime auto loans the past year while recoveries on defaulted subprime loans have gone down.
Nonperforming auto loans, delinquencies, and net charge-offs (NCOs) – debts that are unlikely to be collected – have also been on the rise. NCOs remain manageable at less than 1% though.
Companies into auto leasing also reported increasing depreciation due to declining used-car prices per the Manheim Used Vehicle Value Index and the National Automotive Dealers Assn or NADA.
Of Auto Lenders and Lessors
S&P said banks remain the foremost source of retail auto financing, exhibiting steady growth over the years. Credit unions, captive auto finance companies and other financial institutions also took their place in the market growing at even faster rate.
Take for example new auto loans and leases. Citing Experian Automotive data, S&P reported that banks took 32.9% market share in the fourth quarter of 2016, down from 35.6% from a year ago. This contrasted to the bigger market share that all other auto finance companies took.
S&P believes that U.S. banks are well-positioned to manage auto finance risks because of their limited exposure to subprime lending and leasing. But certain banks into subprime lending like SHUSA and engaged heavily in auto finance like Ally could sustain rising losses.
Santander Holdings U.S.A (SHUSA) had a 29.9% exposure in auto finance with mostly subprime borrowers with FICO scores below 600 or no FICO score at all for the year ended 2016. SHUSA could well be the nation’s largest subprime lender, said S&P.
Captive auto companies also face the greatest exposure to leases that have increased dramatically post-financial crisis. Auto leasing accounting for more than 31% of all new car transactions in the first half of 2016 per Experian data. A separate Edmunds data revealed that 2.2 million vehicles were leased in the first half of 2016, twice their number during the same period in 2011 and up 13% from the same period in 2015.
Per S&P, non-bank auto finance companies, DriveTime and CreditAcceptance face the risk of more borrowers defaulting on their subprime auto loans and that a decline in used-car prices will affect their recoveries. While neither has a material exposure to leases, used-car prices crucially determine their recoveries from loan defaults. Not only will they hamper recoveries, declining prices in used cars can lead to defaults as well.
Subprime Lending, Leasing
The competition for subprime auto lending has intensified in recent years. And with increased competition is the weakening of underwriting.
S&P observed that some lenders have curbed their auto loan appetite after seeing the ease-up in underwriting standards. This should reduce the possibility of a major increase in auto loan losses and a significant drop in used-car prices. A strong economy and employment conditions could help in that regard.
“Still, after years of robust growth and loosened underwriting, a continued rise in loan losses and a drop in used-car prices seem likely. The questions are how will used car prices fall — especially for the captives — and how substantially will delinquencies rise — especially for nonbank auto lenders as well as a handful of banks,” S&P concluded.