An enlargening number of Americans have stopped paying their car loans, and Wall Street is commencing to worry
A rusted car. Mihnea Stanciu/Flickr
Wall Street is beginning to worry about the auto loan market.В
Fitch, Moody’s, Morgan Stanley, Mizuho and Evercore ISI have all published research on the market in the past few days, and there’s a recurring theme: It’s not looking good. There could be wide-ranging consequences, with automakers, the economy, consumers and one corner of the bond market all potentially taking a hit.В
The enlargened interest in the auto loan market seems to be based on commentary from Ally Financial, feeble guidance from Ford, and what Evercore ISI called "a splurge in incentive spending." Here’s what you need to know:
- The delinquency rate for subprime auto loans is at the highest level in at least seven years.
- Banks are pulling back, and newer players with looser lending standards are stepping in.
- Used vehicle prices are ripping off sharply, as the market is flooded with off-lease vehicles.
- The percentage of trade-ins with negative equity is at an all-time high.
- Asset-backed securities based on auto loans are demonstrating signs of stress.
- A growing proportion of the auto loan Six pack market is now made up of "deep subprime" deals.
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Fitch: "Deteriorating credit spectacle will be more acute in the subprime segment."
The 60+ day delinquency rate for subprime is atВ the highest in at least seven years, according to Fitch.В
Previously,В Steven Ricchiuto, Mizuho’s chief US economist, highlighted a hop in losses on subprime auto loans, movingВ to 9.1% in January, up from 7.9% in January 2016.В В
And in November, the Fresh York Fed’s Liberty Street Economics blog looked at theВ deteriorating spectacle of subprime auto loansВ and set off the alarm.
"The data suggest some notable deterioration in the spectacle of subprime auto loans. This translates into a large number of households, with harshly six million individuals at least ninety days late on their auto loan payments."
Fitch: There has been "an expansion of less-tenured independent auto finance companies that have demonstrated higher-risk appetites and less underwriting discipline."
Newer players are emerging, and picking up market share as banks display signs of pulling back.В
"Independent finance companies and credit unions gained the most ground in 2016, ending the year with 20.5% and 25.4% market share, respectively," Fitch said.В The increase for finance companiesВ was especially striking, with this group moving from Legal.9% to 20.5% in twelve months.В
Fitch highlighted the impactВ auto finance companies wereВ having on the market:В
"Fitch expects that deteriorating creditВ spectacle will be more acute in the subprime segment, driven to some extent by the expansion of less-tenured independent auto finance companies that have demonstrated higher-risk appetites and less underwriting discipline."
Fitch: "Used vehicle prices were down 1.6% sequentially in February, reflecting the sharpest monthly decline for the index since November 2008."
Meantime, used vehicle values are falling.
"NADAвЂ™s Used Vehicle Price Index, which measures wholesale prices of used vehicles up to eight years old, declined over 6% in two thousand sixteen and was down 8% year over year through February 2017, marking the eighth consecutive monthly decline. Used vehicle prices were down 1.6% sequentially in February, reflecting the sharpest monthly decline for the index since November two thousand eight and a seasonal anomaly for February."
Evercore ISI: There was a "acute deterioration in the auction spectacle across all of FordвЂ™s deals" from the summer of last year onwards.
The acute drop in residual values seems to be a result of a surge in supply, as off-lease vehicles become available, driving prices down.
Evercore ISI said in a note: В
The development at Ford is aligned with details provided by the company. Interestingly, Ford Credit CFO Marion Harris remarked that вЂњlower values. are not a reflection of request, they indeed are just a [result of] supplyвЂќ. Hence, it would seem that a step-up in supply of vehicles coming off-lease explains the dramatic falls witnessed in September and October. And we suspect that the improvements seen more recently can be attributed to a more moderated supply.
Moody’s: "The percentage of trade-ins with negative equity is at an all-time high, as is the average dollar amount of that negative equity."
In a note out March 27, Moody’s highlighted what it called a "trade-in treadmill." In other words, auto lenders are choosing to roll negative equity at trade-in in to the next vehicle loan.
It looks a little like this:
- Car Buyer acquires aВ Truck one for $100, taking out a $80 loan to make the purchase.В
- Truck one drops in value by half by the time Car Buyer determines to trade in.
- In that time, Car Buyer has only paid $Ten of the loan, leaving him/her with $20 in negative equity ($80 loan minus $Ten payment minus $50 trade-in)
- Car Buyer rolls the $20 negative equity in to the next loan on the next purchase.В
From Moody’s note:В
The percentage of trade-ins with negative equity is at an all-time high, as is the average dollar amount of that negative equity. Lenders are increasingly faced with the choice of taking on greater risk by rolling negative equity at trade-in into the next vehicle loan. We believe they are increasingly taking this choice, resulting in mounting negative equity with successive new-car purchases. This вЂњtrade-in treadmillвЂќ generates higher loan to value ratios, slower principal amortization and higher loss severity when defaults occur.
Morgan Stanley: "Across prime and subprime Six pack, 60+ delinquencies are presently printing at 0.54% and Four.51%, respectively, with the latter approaching crisis-era peak levels (Four.69%)."
Asset-backed securities based onВ auto loans are showcasing signs of stress, with the subprime auto Six pack delinquency rate closing in on crisis-era peak levels.В
Here’s Morgan Stanley:В
"Across prime and subprime Six pack, 60+ delinquencies are presently printing at 0.54% and Four.51%, respectively, with the latter approaching crisis-era peak levels (Four.69%). Default rates are also picking up in similar style (prime: 1.52% ; subprime: 11.96%), printing close to crisis levels. While prime severities leisurely crept past 50% recently, subprime severities have breached 60%, a level we haven’t seen since late 2009. With both default rates and loss severities trending up, it is no surprise to see annualized net loss rates moving in the same direction."
Morgan Stanley: "The securitization market has become more powerfully weighted toward deals that we would consider deep subprime."
A key driver of the enlargening delinquency rate is a spike in the proportion of "deep subprime" deals, or those with an average FICO score of less than 500.
Here’sВ Morgan Stanley:
"The securitization market has become more intensely weighted toward deals that we would consider deep subprime – those with a weighted average FICO score below 550. In fact, since 2010, the share of Subprime Auto Six pack origination that has come from these deep subprime deals has enlargened from Five.1% to 32.5%. This growth has been augmented, if only slightly, by the emergence of fresh deep subprime lenders – those who had not issued a deal before 2012."