Nervousness Creeps Into Subprime Auto Sector
Has the subprime auto-loan boom run its course?
As the amount of financing extended to buyers with spotty credit histories has exploded in recent years, lenders in the sector have sought to sustain that growth by relaxing the minimum credit-quality standards for borrowers. The result has been a gradual weakening of loan performance that some now view as evidence of a coming down cycle.
They envision a scenario in which losses among certain originators’ asset pools would exceed limits set by warehouse lenders, causing them to lose access to some or all of that financing. Without the ability to accumulate loans, those shops also would find themselves locked out of the asset-backed bond market — putting them at risk of failure. “I can’t dispute the fact there will be a casualty or two,” one issuer said. “There are a lot of lenders, even big ones, that are growing like crazy putting a lot of garbage on the books.”
Few dispute the idea that losses will continue to rise. The question is when, or if, loan performance will weaken to a point that warehouse lenders find intolerable.
For many subprime auto lenders, access to warehouse financing automatically begins to shut down when losses reach 8-10%. According to an index maintained by Fitch, average annual losses among securitized pools of subprime car loans have climbed for five straight months, from an average of 3.76% in May to 6.44% in October — a trajectory that worries many industry professionals.
Declining credit quality for 2011-2012 vintage loans is the clear culprit. After losses maxed out around 8-9% during the financial crisis, lenders adopted ultra-conservative underwriting standards that resulted in stellar performance for loans printed in 2009-2010. From there, average FICO scores gradually dropped as larger lenders sought to increase their origination volume and newly established shops faced pressure from private equity backers to grow at a rapid clip.
Take Capital One, which lowered its minimum FICO score to 520 from 540 this year. Ally Bank has made a similar adjustment, while Banco Santander and General Motors Financial have moved slightly down the credit scale.