Subprime Auto Boom Besieged by Late-Payment Jump: Credit Markets
A three-year lending boom to car buyers with spotty credit that helped push auto sales to a six-year high is starting to show signs of overheating.
The percentage of loans packaged into securities that are more than 30 days late rose 1.43 percentage points to 7.59 percent in the 12 months ended September 30, according to Standard & Poor’s. That’s the highest in at least three years, the data released last week by the New York-based ratings company show.
“We’re at this inflection point,” Amy Martin, an analyst at S&P, said by telephone. “Now that they are opening the lending spigot, it’s only natural that losses are starting to rise.”
Underwriting standards began to decline amid five years of Federal Reserve stimulus that set off a race for higher-yielding assets, spurring a surge in issuance of bonds tied to subprime auto loans. That breathed life into a car-finance business that had contracted in the wake of the credit crisis, attracting new lenders and private-equity firms such as Blackstone Group LP (BX) with cheap funding and high margins.
Delinquencies on subprime auto loans are likely to have increased more during the fourth quarter, the holiday period when consumers typically stretch their budgets, according to S&P. That’s poised to increase losses that bondholders will take from defaults on the debt, which stood at 6.92 percent at the end of September after falling to as low as 4.15 percent in 2011, S&P data show.
“Many lenders have told us that their performance in recent years exceeded their expectations,” Martin wrote in a report last month. “We are now hearing that they expect losses to trend upward to more normal levels this year and next.”
Loosening underwriting standards and the subsequent rise in defaults is part of the “normal ebb and flow of consumer lending,” she wrote in the report, titled “Subprime Auto Loan Performance: The Best is Behind Us.”
Late payments on auto loans to customers with good credit are rising “very modestly,” and remain under 1 percent, according to S&P’s Martin.
The subprime auto segment ballooned as private-equity firms entered the business. New York-based Blackstone acquired Irving, Texas-based subprime lender Exeter Finance Corp. in 2011, the same year that Perella Weinberg partnered with CarFinance Capital LLC. Lenders charge as much 19 percent on vehicle loans to borrowers with bad credit, according to S&P.
American Credit Acceptance, a Spartanburg, South Carolina-based finance company, had the highest delinquency rate among companies tracked by S&P, with 15.2 percent of loan balances late as of September. The company specializes in deep-subprime lending, according to its website, referring to borrowers with the weakest credit profiles.
Subprime lenders have found cheap funding in the bond market, with $17.6 billion of asset-backed securities tied to subprime auto loans issued last year, more than double the $8 billion sold in 2010, according to Barclays Plc. About $3.6 billion of the securities have been offered this year, according to data compiled by Bloomberg.
Top-rank bonds maturing in two years are yielding 37 basis points more than benchmark swap rates, compared with a 52-week average spread of 39 basis points, Wells Fargo & Co. analysts said in a Feb. 28 report. Detroit-based Ally Financial Inc. issued top-ranked, two-year debt in January to yield 0.97 percent, or 27 basis points more than swaps, Bloomberg data show.
The increasing competition has sparked concern that firms are lowering their standards to win business. Auto buyers are taking out longer loans and borrowing more relative to the value of the cars as lenders relax debt terms, Moody’s Investors Service said in Jan. 10 report, noting that defaults are rising even as the unemployment rate drops.
“Subprime auto lending from banks, captive finance companies and credit unions continues to increase and is pressuring more traditional subprime lenders to lend to ever-weaker borrowers to maintain lending volumes,” Moody’s analysts led by Peter McNally wrote in the report.
Vehicle repossessions for finance companies are rising along with delinquencies, increasing 1.23 percentage points to a rate of 2.84 percent in the last three months of 2013, the highest recorded since Experian Automotive started tracking the data in 2006. The jump was tied primarily to soured subprime loans, according to Melinda Zabritski, a credit analyst at Experian.
The default rate, while rising, is still within expectations, according to Rosemary Kelley, an analyst at Kroll Bond Rating Inc.
“Nothing we see is cause for alarm at this point for the transactions we rate,” Kelley said in an interview.
Losses on bonds linked to subprime auto loans are rising toward pre-crisis levels, though the current rate is “well within historical levels,” Fitch Ratings said in report last week.
Those losses may be more difficult to absorb for smaller companies with less capital if profit margins shrink, bond grader DBRS Ltd. said in a report yesterday.
Such firms also may have inadequate systems to handle the lending volume, which could lead some to skip steps in the approval process, including verifying incomes and residences, as they rush to write loans, S&P’s Martin said.
“Companies that grow rapidly may not have the infrastructure in place to do all the same things they did when they were small,” she said. “That’s a risk we have to look for.”
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