CREDIT: Delinquencies Remain Low Even as Subprime Grows

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DELINQUENCIES

Auto loan delinquencies are on the rise, loan terms are getting longer, and as subprime auto lending continues to grow, so does the fear that the industry is on the brink of creating a similar financial crisis that caused the recession about five years ago.

That’s the upshot in auto finance credit performance today.

TransUnion, the credit bureau, has predicted that delinquencies will rise to 1.27% by the end of 2015, up from 1.20% last quarter. But Jason Laky, automotive business leader and senior vice president in TransUnion’s financial services unit, believes that credit performance is a sign of recovery in subprime, rather than a cause to raise the alarm.

“Subprime and nonprime, as a percentage of the total loans — even still among balances — is well below where they were pre-recession,” Laky said. “While we are forecasting delinquencies to be higher, it’s more a function of good growth continuing to happen in auto finance as opposed to dangerous growth or ‘bubble’ things that we hear.”

The “bubble” talk Laky referred to, began during the summer after some media outlets began examining the state of subprime auto lending to determine whether a financial bubble within auto finance was set to burst, much like the mortgage crisis.

“’Bubble’ is such a difficult term, it’s a broad term, and applying it to auto finance is not the same as applying it to other things,” Laky said. “There are really some good fundamentals with auto loans. The fundamentals behind auto lending, I think, are strong, and even as we go into subprime lending, more it’s a function of a good economy. As unemployment comes down, people are coming back into the market to get auto loans, because they need to get to their jobs. Typically, people that have been out for a while may be coming in at more of a nonprime or subprime position. It’s great that there are lenders out there for them.”

UNEMPLOYMENT

The unemployment rate is expected to drop to 5.8% in 2015, and 5.7% in 2016, according to Standard & Poor’s US Consumer ABS 2015 Credit Outlook report.

Unemployment has been steadily falling since 2012, when the rate was at 8.1% for the year.

In 2012, lenders were more selective about borrowers, and now that market conditions have improved, there’s more access to auto loans, according to S&P. Credit availability was limited and lending was tight during the recession. As market conditions started to improve, however, lenders are now more willing to extend credit and auto loans to borrowers, S&P noted in a report.

The subprime sector is generally where weaker credit characteristics will show, the rep from S&P said, and in the report, the ratings agency expects subprime auto loan ABS collateral to experience higher losses in 2015.

“We expect the 2012 and 2013 vintages to report weighted average losses of approximately 12% to 13% through Month 43 given how they are trending along with the current economic conditions,” according to the report. “However, this higher level remains well below the peak levels of 14.7% to 15.5% for the 2007 and 2008 vintages through Month 43.”

LOAN TERMS

How large a problem is the lengthening of loan terms?

Apparently, not that problematic. At American Financial Services Association’s Vehicle Finance Conference last week, Jason Kulas, president & chief financial officer, Santander Consumer USA — primarily a subprime auto lender — said that the majority of longer-term loans are not a result of dealers advising customers to get a 60-month loan and buy a cheaper car, or get a 72-to-80 month loan and get a more expensive car.

“That’s another conversation,” Kulas said. “That’s not what we’re seeing.”

The volume of loans with terms of 61-to-72 months increased 40% last October and November, while loans with 73-to-84-month terms climbed 26%, according to Experian Automotive released last week.

INSIGHTS: Back to Normal?

The growth market in auto finance remains in … nonprime/subprime.

That’s the view of TransUnion’s Laky.

Because of the recession, Laky said, there was a pull-back in nonprime and subprime lending, and while accounts and balances have grown industrywide as conditions have improved, nonprime/subprime origination volume still falls short of prime volume.

“To me, that means there’s opportunity to grow,” Laky said. “So as the economy recovers, when lenders are looking to expand, it’s very natural to do more nonprime and subprime loans.”

BBVA Compass, historically a prime auto lender, is one lender that is looking to expand down the credit spectrum in 2015, planning to go all the way down to subprime, said Shayan Khwaja, executive vice president of direct consumer finance at BBVA. The rise in delinquencies and lower losses is a result of the industry starting to return to pre-recession levels, not a bubble waiting to pop, Khwaja said.

“We see some marginal increases, but nothing too significant of a move,” he said. “It does need to normalize from this point. I see those articles and I see that data every day, but it’s nothing alarming from our perspective. Even on the lower spectrum, it’s been performing really well, so those numbers have to come up, but that’s expected.”

This post is the first of a regular series where The Center for Auto Finance Excellence will evaluate the state of credit quality in the sector.

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