CREDIT: Subprime Inches Up as Delinquencies Remain ‘Under Control’

© Can Stock Photo Inc. / chillAuto loan delinquencies are “under control,” despite a continued rise in subprime lending, while recent concern about a so-called subprime “bubble” slowly deflates.

That’s the upshot of auto finance credit performance today, analysts said.

Subprime Continues to Rise

Subprime or nonprime loans, as a percent of all lending, are at 18.2%, according to Jason Laky, senior vice president and automotive business leader for TransUnion, and have remained between 18% and 19% since the first quarter of 2013.

“Prior to that it was generally higher, and if you look all the way back to when we measured it in Q4 of 2009,  23.5% of consumers were subprime,” Laky said. “So on an absolute basis, more subprime consumers are getting loans, but as a total of all outstanding balances, subprime remains, I think, well under control.”

On the opposite end of the spectrum, super prime loans, which Transunion defines as a VantageScore credit scores of 780 or higher, have also been on the rise, helping to offset that increase in subprime too, Laky said.

“Super prime is 23.3% of consumer balances and that is compared to Q4 2009 when it was 20.7%. That, I think, reflects a couple of things,” he said. “Super prime consumers are generally taking out larger loans, but also because of our really favorable interest rate environment, many consumers who might have chosen to pay cash, can find really good financing offers either through their banks, or through the captive financing companies.”

Delinquencies Near ‘Historic Lows’

The economy remains strong, thanks to a decrease in the unemployment rate, Laky also said, because when employment is strong, consumers are in a position to be making payments on their loans.

In fact, the unemployment rate, which was 5.5% in May, was down 12.7% annually, according to Standard & Poor’s latest U.S. Consumer ABS 2015 Credit Update report, released in mid-July. Unemployment has been steadily falling since 2012, when the rate was at 8.1% for the year, according to S&P.

Admittedly there has been a continued decrease in the unemployment rate, said Troy Cavallaro, chief executive at Pelican Auto Finance, LLC, but seasonality still can play a part in how subprime loans perform in particular, driving delinquencies higher during certain times of the year.

“In terms of winter, we’re competing with Santa Claus, and the overtime isn’t there,” Cavallaro said. “You’re [also] seeing the typical seasonality right before school start where you see a rise in delinquencies, as well as around the holidays. But generally speaking, year over year the delinquencies are conforming to their expected curves.”

Delinquencies are “under control, and near historic lows,” Laky said, with moderate delinquencies of 60 days+ nearly flat, and serious delinquencies of 90 days or more are in decline. For the second quarter, serious delinquencies accounted for 0.95% of outstanding loans, down from 0.98% a year ago, according to Transunion data. That was the lowest level since the second quarter of 2013, when the delinquency rate dropped to 0.86%.

Transunion had originally projected that the 60-day national auto loan delinquency rate would be at 1.27% by the end of the year.

Still No Bubble

However, despite a steadier employment picture and strengthening economy, there is always an interest in the performance of subprime and nonprime auto loans, Laky said, because some use it as a barometer of where the industry is heading.

“If we expand in subprime rather quickly, is that a sign that lenders are taking on new risk,” Laky said. “What I’ve said, and I continue to say, is when you look at subprime as a proportion of the balances, and you look at the ongoing level of delinquencies, and for folks overall that are in subprime, there is no reason to think that there is some kind of bubble.”

The negative stigma attached to subprime auto stems from the last credit crisis brought on by the collapse of the mortgage industry, Cavallaro said, which has fundamental differences from the auto finance industry.

“Everyone was looking at the mortgage business, which heated up and then melted down,” he said. “But the reality is, with all the ‘creative mortgage products’ that were made during the mortgage bubble, they were lulled into believing that the underlying asset was either going to maintain its value or continue to appreciate.”

Underlying real estate values were so strong for so long, he said, that some investors lost sight of what is embedded in subprime auto, and that is an underlying, depreciating asset.

“What people fail to realize is this, and this is a fundamental part of the business, auto finance originators have always expected the underlying collateral to depreciate,” Cavallaro said. “And that’s been part of our core model.”

Growing regulatory scrutiny has resulted in some players exiting the subprime auto market, he said, such as Condor Capital, a N.Y.-based subprime auto lender sued by the New York Department of Financial Services last year.

“You’re seeing some smaller players evaporate and what’s left, really, are the sophisticated players, that know what they’re doing, are very smart, have a lot of institutional money behind them, and quite frankly they’re playing by the book,” Cavallaro said. “They’re playing by the book from a risk perspective, and playing by the book from a compliance perspective.”

This post is the second 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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