Subprime Just Fine, Dire Predictions Aside

LAS VEGAS – Subprime is fine, despite some dire predictions that a resurgence of such low-level lending could end badly, say automotive conference attendees here. They doubt a calamity is coming.

Vying for more business, conventional auto lenders have become more aggressive lately, showing a greater willingness to dive into the deep waters of the subprime sector.

“It has become a highly competitive market,” says Jonathan Banks, a chief analyst at the National Automobile Dealers Assn.

That’s led skeptics to worry about today's relaxed lending practices ultimately causing widespread loan delinquencies and defaults. But attendees of the 2014 National Remarketing Conference show optimism about the growing subprime auto segment.

“Don’t take the bait on claims that there will be a bubble,” says Joy Wilder Lybeer, a senior vice president at Equifax, a credit-reporting firm. “Subprime is as healthy as it’s ever been.”

Five years ago, it barely had a pulse. The subprime mortgage-industry crisis caused a general credit collapse. Subprime auto lending suffered collateral damage, even though it had performed relatively well because economically distressed people tended to put car payments ahead of mortgage obligations. 

Overall credit availability became scarce during the economic crisis. Getting a car loan required sterling credit. That blocked out the subprime sector, adding to auto industry woes. Sales fell to 10.6 million units in 2009. A recovering industry is expected to deliver 16.5 million this year, according to WardsAuto.

Automakers and dealers rely on subprime customers to reach such levels, Lybeer says, adding that special financing, done right, is not the high-risk behavior some critics claim it is.

“One in every three cars sold goes to a subprime borrower, and those loans are performing well,” she says, citing historically low delinquencies, defaults and repossessions as a percentage of outstanding loans.

In the past, the typical subprime customer was someone who, for whatever reason, had a generally bad credit history.

But many current subprime consumers differ from those of a decade ago, says Eric Ibara, director-residual value consulting for Kelley Blue Book. “Today, many of them are people who are rebuilding their credit” after suffering a job loss or other recession-related setbacks.

That has affected how lenders look at credit scores.

“A score of 580 today is as good as 620 was five years ago,” says Ricky Beggs, senior vice president at residual tracker Black Book. “A lot of cars and a lot of customers fit into the subprime category. It’s not a bad part of the industry.”

Subprime buyers “look different” than before and “banks are looking at more information than just credit scores” in determining creditworthiness, says NADA’s Banks.

“Credit scores alone aren’t enough,” Lybeer says. “We work with dealers and lenders to know as much as possible about a person’s finances. Income and employment are critical, including time on the job. Also important are levels of wealth and assets.”

When the dust settled after the credit-industry collapse of six years ago, it became apparent that although subprime mortgages performed abysmally, subprime auto lending actually did well under the circumstances.

That’s one reason many lenders have become more active in automotive subprime.

“Subprime used to be split between mortgage and auto, but then lenders became timid about subprime mortgages and shifted heavily to automotive,” says Ingram Walters, owner of two buy-here/pay-here auto dealerships in North Carolina.

He says that shift to subprime auto has hurt his business, which depends on selling high-mileage, low-priced cars to the credit challenged. A dealership itself provides the financing at buy-here/pay-here operations. Those cater to car buyers whose credit ratings are so low, they barely qualify for a loan.

“Auto lenders are reaching down and taking some of our best customers,” says Walters, whose family also owns four franchised dealerships in the Charlotte area. Business at his special-finance dealerships is off about 25%. He quips, “It was so bad last month, even the customers that didn’t intend to pay me quit buying.”

Walter sees potential risks to both lenders and his former customers when financial institutions make it possible for people with credit issues to buy cars priced beyond their means.

“Those companies are putting people in cars they shouldn’t be in because they can’t afford the payments,” he says. “Some of them are buying new cars or low-mileage used cars when they should be buying the less-expensive cars we sell.”

About 90% of the clientele at Tracy Myers’s used-car dealership are special-finance customers.

“We learned the subprime market is very loyal,” says the owner of the Frank Myers Auto Group. “We market more the store and the benefits we provide rather than the vehicle itself.”

Myers agrees the face of the subprime customer has changed. “Ten or 15 years ago, you could easily paint a picture of that person. Today, it could be a doctor who fell on hard times. What we’re seeing now is part two.”

Experian Automotive, a credit-tracking firm, says 30- and 60-day automotive-loan delinquencies were up in the third quarter of 2014.

Its latest State of the Automotive Finance Market report says 30-day delinquencies grew 3.7% from the previous year. Similarly, 60-day delinquencies were up 8.6% during the same time period.

But those increases need context that takes into account the rise in subprime lending, says Melinda Zabritski, Experian’s senior director of automotive credit. 

“While we have observed a rise in delinquencies over the past few quarters, it was to be expected due to the growth in subprime loans,” she says. “We have to keep in mind that a majority of the market is still in the prime risk category.

“As long as consumers continue to do a good job of making their auto-loan payments on time and lenders keep a close eye on how rates fluctuate year over year, the industry should remain relatively stable.”

It’s important for the market to understand the shifts in payment behavior and the industry’s risk tolerance because “these insights can trigger actions that affect vehicle prices, loan terms or interest rates,” Zabritski says.

The Experian report shows that, at a state level, states in the South accounted for four of the top five highest delinquency rates in both the 30- and 60-day category.

On the flip side, the states with the lowest delinquency rates in both categories primarily resided in the Midwest and Northwest regions.

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