Subprime Becomes Too Rich for Some Lenders’ Blood

Auto-loan delinquencies are up, mainly because of the usual suspects: subprime borrowers behind on their bills, according to credit tracker TransUnion.

And although some lenders are pulling away from the subprime and non-prime segments, it’s not a mass exodus. Lenders who specialize in that segment welcome the thinning out of the competition.

So says Brian Landau, TransUnion’s senior vice president-financial services and automotive business leader.

The company’s latest Industry Insights Report says total U.S. auto loans last year reached $1.2 trillion, up from $1.05 trillion. The average auto-loan balance rose to $18,368, up 1.8%.

The delinquency rate increased from 1.16% in the first quarter of last year to 1.30% in this year’s first quarter, driven by poor loan performance in the subprime and near-prime segments, TransUnion reports.

(Experian, another credit bureau, reports 30-day delinquencies dropping from 2.1% in 2016’s first quarter to 1.96% in this year’s, while the total share of subprime and deep-subprime loans dropped from 26.8% to 24.1%.)   

“Serious auto-loan delinquency rates are approaching levels not seen since the recession,” says TransUnion’s Brian Landau, adding that it’s important to keep it in perspective. He does so in a WardsAuto Q&A. 

WardsAuto: Delinquencies have ticked up and lenders are pulling back. Why are they? With subprime, isn’t there an established market and inherent risk, and everybody was relatively comfortable with that?

Landau: I can’t speak about any particular auto lender, but there are a number of different headwinds right now. First of all, we had some banner years and more financing than ever before, a lot of it driven by increased subprime and near-prime penetration. That’s slowing down a bit.

On top of that, we’re seeing some pressure on residual values. That affects the market.

WardsAuto: The pressure is because of the waves of off-lease cars hitting the used-car market?

Landau: That, and also the pressure OEMs are applying to sell new vehicles. Incentives are reaching 10% or more of the average transaction price.

Consumers see the surplus of used vehicles on dealer lots, and they’re enticed by the incentives. That puts pressure on values.

Then there’s a general uptick in delinquencies, primarily around non-prime borrowers. The levels are kind of approaching what we saw around the recession.

WardsAuto: What’s going on there?

Landau: I wouldn’t say it has anything to do with the economy. The GDP still is growing at a healthy rate. Unemployment is at a 5- or 6-year low. It might have had to do with lenders over-indexing a bit, as well as some consumers on the fringes overextending themselves.

We’re now seeing lenders tightening up some underwriting requirements, such as extended terms. Some are pulling back on 84-months and requiring more upfront payments.

WardsAuto: But doesn’t it make sense that if subprime lending increases, so will delinquencies, to some extent anyway? That shouldn’t come as a big surprise, given the nature of behavior by credit tiers.

Landau : You normally expect that, opposed to what you expect from other borrowers across the risk spectrum. But we’re seeing a higher pace of it. Our analysis looks at different time periods specifically relating to subprime and non-prime borrowers. The delinquencies are rising over time.

WardsAuto: How high does an average delinquency rate have to go before alarms start sounding?

Landau: I don’t necessarily have an answer to that, but I will say this: Auto,  relative to other assets within financial services, is pretty steady. If you go back to the financial crisis of 10 years ago, the (auto-lending) delinquencies were certainly up, but not as volatile compared with mortgage.

Auto is pretty high up on consumers’ prioritized (loan) payment list, more so than mortgage or credit card.

There are some concerns, debunked by many out there, that (auto financing) is sitting on a subprime bubble. Our position is we’re not, because of what I just said. Also, there are a lot of smart people who have been in the industry a long time and have seen these types of situations in the past. Throughout different economic cycles, they know what to do and what the lead indicators are. They manage that accordingly.

WardsAuto: Subprime risk management never completely disappeared or went nuts in the auto financing sector.

Landau: Correct. I’ll say this, too. Even though a lot of growth has come from the subprime space, the percentage of share has been pretty steady, increasing only about 2 percentage points over the last few years. Yes, there has been increasing attention on subprime, but it hasn’t been the dominant market segment.

WardsAuto: What is the dominant segment?

Landau: Primarily prime and above.

WardsAuto: Well, that’s good news.

Landau: Yes. Think about lease penetration. It is 30% of new-vehicle transactions and financing right now. That’s as high as I’ve seen it. And leasing is primarily geared towards prime and above consumers.

WardsAuto: If you are going to have a lead segment, it’s good that it’s prime or above, although in a sense that is determined by the lenders based on who they are and aren’t lending to.

Landau: Exactly. And those who do play in the subprime space are good from underwriting and collection standpoints. They know the business well.

WardsAuto: As the lending industry became more competitive, more financial institutions got into subprime. That wasn’t their core competence, but they took it on. Is that still the trend?

Landau: Yes. A lot of classification is happening. You’re seeing the first spectrum of lenders dabbling in subprime and now pulling back a bit. Whereas, this is the turf of the incumbents; the subprime lenders and buy-here/pay-here dealers. They see the pullbacks of others as great opportunities because there is less competition.

WardsAuto: Is there a higher risk of getting burned for a lender who doesn’t specialize in subprime to get into it beyond dabbling?

Landau: The environment has changed quite a bit. Ten years ago there wasn’t as much information on consumers as there is now.

Everyone is talking about alternative data, about getting information that goes beyond just the credit report.

WardsAuto: This is looking at things like phone-bill payments that typically wouldn’t be included in a traditional credit report?

Landau: Exactly. Are they making good on their utility bills? Their rent? Those types of things. That information wasn’t available 10 years ago. It’s easily accessible today. You’re seeing a voracious appetite for this information from the subprime and near-prime lenders who use it to make their underwriting decisions.

WardsAuto: Some people think there is too much auto debt out there. Is there?

Landau: I can’t answer that other than to say we have a supply and demand that works pretty well. The lenders are acting as referees to determine how much a consumer should take on. The lenders have to own the collateral at the end of the day. That’s their risk.

As cars get more expensive and the cost for them grows at a faster rate than the average household income, financing becomes more of an option. Growth rates for car loans and leases is growing faster than the actual growth rate of new- and used-vehicle sales. Credit is pretty cheap and access to financing is not that hard.

WardsAuto: How would you rate the health of the auto-finance market today?

Landau: What people are reading today (about an impending subprime crisis) is an exaggeration of a slight change in the market. Some people are hypersensitive to what’s happening in a normal business cycle. It’s the market recalibrating.

I’m not saying we’ll have the banner year we had last year, but we’re not going to have a crash either. I’m confident in saying that. 

[email protected]