Are car loans a slow-motion car crash?

Subprime: reckless drivers

The first step in understanding trends in auto credit is to look at the pool of US auto loans broken out by the borrower’s creditworthiness: prime versus subprime.

Of course, the term “subprime” triggers alarming flashbacks to the global financial crisis. Subprime mortgages played a big role in the financial meltdown that ran from 2007-2009. However, we believe that the deterioration in subprime auto loans has less severe implications.

Delinquency rates in subprime loans have indeed seen a significant deterioration. On the other hand, the data for higher quality borrowers looks much more like that in other areas of consumer credit i.e. delinquency rates are normalising, but remain at low levels.

Loans passing more than 90 days overdue, by credit score at origination
(Four quarter moving average)


Despite headline-grabbing comparisons with mortgage-backed securities, subprime auto lending is quite a small pool. Subprime auto loans, at $270 billion, represent only a minority (25%) of total auto lending and a tiny proportion (2%) of the $12.6 trillion total in US consumer credit.

Furthermore, investors should remember that not all lenders are taking the same levels of risk. Subprime auto lending has grown since the crisis, but the data suggests this has not been driven by systemically important banks or automotive captive finance companies or “fincos”2.

The culprits behind the rise in subprime auto loans are primarily new entrants to the market: mostly private equity-backed non-bank financials (NBFs). NBFs have accounted for the vast majority of sub-prime auto lending in recent years, and are even more dominant in the “deep-subprime” space: lending to those with extremely low credit scores, or none at all.

Meanwhile, established lenders have actually been pulling back from this part of the market, with new lending by market leaders Santander Consumer and Ally Financial down 25% in Q4 2016. Federal Reserve surveys show tightening bank lending standards in auto loans since early 2016. Automotive fincos have very modest exposure to subprime.

Some NBFs will likely come unstuck when we experience an economic downturn (or sooner), but mainstream lenders should be relatively well insulated.

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