Unlocking Credit

Subprime auto securitization has been firing on all cylinders lately: The strong financial condition of borrowers, good loan underwriting and a solid market for used cars have all kept investor losses on the 2009, 2010 and 2011 vintages to a minimum.

But it is only a matter of time before the market hits some speed bumps. Demand for bonds backed by auto loans, leases and dealer financing is making it ever cheaper for lenders to fund loans. This will inevitably result in a loosening of underwriting practices as new lenders join more established ones competing for borrowers.

If this sounds a lot like the scenario heading into the last recession, you can see why the credit ratings agencies and other market participants are keen to advertise that they are aware of the potential risks.

At the same time, the ratings agencies are at pains to convey that any deterioration in underwriting will be gradual and is unlikely to affect the performance of auto loan securitizations, thanks to the strong structural support in these deals.

At least not in 2013.

In the Federal Reserve’s latest Senior Loan Officer Survey, conducted between Dec. 27, 2012 and Jan. 15, 2013, domestic banks indicated that they had again eased standards on auto loans over the previous three months. That was in contrast to lending standards for credit cards and other types of consumer loans, which were little changed.

On balance, several banks reported that they had reduced spreads on consumer loans other than credit card loans. A “modest fraction” of banks also reported having increased the maximum maturity of auto loans, on net, while standards on other types of consumer loans were almost unchanged.

Respondents eased many components of their lending standards, including extending the maximum maturity (13.1%), narrowing spreads on loan rates over costs of funds (27.8%), lowering minimum required down payment (6.6%), and minimum required credit score (3.3%).  

This expansion is partly reflective of how much lending contracted during the financial crisis.  It also reflects the facts that auto lending didn’t prove to be nearly as troublesome as mortgage lending.

“Banks didn’t do that badly in the downturn with auto loans, even subprime,” said Jeremy Anwyl, vice chairman of Edmunds.com, the online car buying guide. “If buyers don’t make payments, they pick up the car, turn around and sell it.”

Easier underwriting standards aren’t the only ways lenders are looking to compete for loans.  Chrysler Group is looking to reduce the time it takes to complete auto purchases.

Peter Grady, Chrysler’s vice president of dealer network development and fleet operations, said that the industry-wide average for the approval process is almost four hours, and that this is a “big dissatisfier” with customers, a Chrysler spokesman confirmed.

The U.S. automaker, which is forming an auto-financing venture with Spain’s Banco Santander, may try to cut the time in half, he said.

Grady said that Chrysler was also interested in Santander’s expertise in so-called “automated decisioning,” which uses data modeling to speed the assessment of loan applications and set appropriate terms for the borrower.

Grady’s comments, made at the National Automobile Dealers Association convention on Feb. 9, were originally reported by Bloomberg. Grady declined a request to be interviewed for this article. A spokesman said the company would have more to say once the joint venture with Santander takes effect in May.

Pent-Up Demand

In the third quarter of 2011, approximately 19.97 million borrowers with a VantageScore credit score lower than 700 (on a scale of 501 to 990) carried auto loan balances, according to TransUnion’s Industry Insights database. By the third quarter of 2012, the most recent date for which data are available, this number had increased to 20.66 million.

The total number of consumers carrying auto loan balances also has increased, to 59.27 million in the third quarter of 2011 to 61.68 million in the third quarter of 2012. Auto loan debt per borrower jumped from $12,902 to $13,571 in those same periods.

TransUnion expects that auto debt per borrower will continue to rise this year, jumping from an expected $13,689 in the fourth quarter of 2012 to $14,133 by the end of 2013.

So far, the expansion of lending to higher-risk consumers hasn’t resulted in higher delinquencies. The auto delinquency rate finished 2012 at 0.36%, down more than 50% from its peak of 0.86% in the fourth quarter of 2008. TransUnion expects the ratio of borrowers 60 or more days past due will rise only slightly to 0.37% in the fourth quarter of 2013.

The data include both loans used as collateral in securitizations and loans held on lenders’ books.