Credit Erosion: Cracks Are Starting to Show in Subprime Auto

Erosion Fitch Ratings reported subprime delinquencies hit a 20-year high in March, and some of the smaller lenders in the space have cut back on originations, stopped issuing securitizations, or shuttered their doors completely, multiple sources told Auto Finance News.

The number of new players entering the space has “slowed down,” Nathan Benson, chief executive of Tidewater Finance Co., told AFN. “There was a tremendous amount of new entries two or three years ago, but now I’m starting to hear of companies really contracting, some of them are going out of business.”

The aftermath of the financial crisis provided an opportunity for new startup lenders to enter the industry and other longtime lenders to start issuing subprime securitizations for the first time. In 2007 and 2008, there were eight to 12 subprime lenders issuing subprime securitizations. Today, the playing field is more crowded, with issuers at somewhere between 23 and 25, said Timothy McNally, associate director of Fitch Ratings’ U.S. ABS group.

In the early days of the crisis, Santander Consumer USA and General Motors Financial Co. made up 85% of the subprime ABS market; today their combined share has shrunk to under 50%, McNally said.

“There are just a lot of smaller lenders that had taken away marketshare from the larger lenders in the space,” he added. “They had sort of driven the loss frequency up with the collateral underwriting that they’ve done.”

While losses among the two big lenders have grown — today they sit between 7% and 12% for GMF, and between 12% and 18% for Santander — some of the smaller lenders are looking at losses as high as 40%, said Hylton Heard, senior director of Fitch Ratings’ U.S. ABS group.

“There are definitely a couple of names out there in the subprime space — the smaller, newer guys — that have hit up against trouble and have actually either merged or shut down originations, period,” he said. “We’ve heard of a couple — three or four names already — that have had loss levels way up out of expectations in the past two to three years, and that has caused them to either service their portfolio down and stop originations — or stop issuing ABS.”

Heard didn’t want to disclose any more recent names, but mentioned DriveTime shuttering GoFinancial last year as early signs of this trend.
“It’s none of the [lenders] you would read in the paper,” Benson said, referring to companies shutting their doors. “Most of the smaller ones won’t disclose that they have done it; you just know from the marketplace.”

Yet, the fragmentation hasn’t led to an increase in mergers and acquisitions like the industry saw in 2009, when Santander went on a buying spree.
Companies could be waiting to see what happens with losses before making any big moves, Benson said. Subprime annualized net losses reached 9.7% in February, compared with the 13.1% loss rate the industry experienced in 2009, Fitch reports.

“There will either be portfolios sold, or consolidation of companies — definitely,” Benson said. “People are still trying to figure out where the bottom is. You never want to do a deal when things are deteriorating. You either want to do deals when things are on the uptick or stabilized.”

Innovate Auto Finance, however, has started to see some portfolios for sale in the secondary market, Scott France, president of the company’s subsidiary Loan Portfolio Servicing, told AFN, and the company has been buying.

“The industry is returning to normal on the credit front and some of the companies have not been able to get their expected returns,” France explained. “As funding continues to tighten, the only way for these companies to fund their business is by selling portfolios.”

Market sources say that unlike in 2009, Santander is not in the financial position to make significant portfolio acquisitions. Santander stock, for example, has lost nearly 14% of its value over the past 14%. However, the delinquencies, used-car values, and losses in these portfolios might just be too unsavory for banks and other potential buyers to take on, said Matt Carroll, senior director at S&P Global Ratings.

“In portfolio sales, you need either a willing buyer or a willing seller — the two parties have to find a price that works for both sides,” he said. “Some of the current trends I think we’re seeing in auto finance may not be particularly conducive to getting the best price for a portfolio sale at this juncture.”

That same sentiment about portfolio sales extends to mergers and acquisitions, which he predicts won’t be any greater in 2017 than it would be in the normal course of business.
Over at Fitch Ratings, however, analysts have said they were surprised there haven’t been more company mergers and acquisitions lately.

“If auto sales decline this year — as we expect they will, marginally — and if there are any issues on the 2013 to 2015 vintage performance from some of these small names, I could definitely see them getting picked off by some of the bigger lenders,” Heard said.

Tidewater started tightening its credit back in the fourth quarter of 2015 in preparation for the downturn, Benson said. While he thinks the company’s record in the ABS market will prove beneficial, other lenders that haven’t been around as long will find it hard to generate capital.

“In terms of volume, we’ve definitely reached a peak. Most of the players that have been around for many years have tightened up, and cut back originations,” he said. “If you’re a first-time issuer, you’re new, and you don’t have a collection platform that’s been proven through the cycle, it’s going to be a tough thing to get done.”

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