Like a car on a bridge buffeted by high winds, subprime auto loans will be challenged on multiple fronts as the other side of the pandemic approaches. It turns out that the anticipated “new normal” could involve a new framework with subprime borrowers under severe financial pressure and regulators monitoring underwriting, servicing and collection practices. It is difficult to know if a market change is temporary or represents a trend, but areas of risk can be identified. We spoke with some industry leaders about their reactions to the state of the market.
Origin and performance
Overall, auto origination for subprime and subprime auto loans declined in 2022, primarily because 2021 levels were historically high. Additionally, lower inventory led to fewer transactions. The New York Fed attributed increases in auto dollars in the first quarter of 2022 to higher vehicle prices. According to data from the New York Fed, subprime origination ((620) has gradually declined over the past four quarters after peaking in the second quarter of 2021 at $35 billion. Today at $27.7 billion originations are close to pre-pandemic levels (in the first quarter of 2020 they were $28.4 billion).
Although the “average balance of new car loans reached $28,415 in the first quarter of 2022 – a 15.2% year-over-year increase,” according to Transunion – we are now starting to see a small decline. The Manheim Used Vehicle Value Index decreased by 1% from March to April.
Rising prices have led to higher loan amounts and payments, but throughout the pandemic there have been enough compensating factors in the market to justify “staying the course and not changing standards.” underwriting,” notes Sean Morgan, senior vice president of finance. at Westlake Financial.
In February, Equifax reported a all-time high for defaults on subprime loans and leases. But some wonder whether Equifax’s chargeback data is too inclusive (including imputations that exaggerate the seriousness of late payments) and TransUnion reported60+ auto subprime delinquencies actually fell from 12.01% in February to 11.19% in March. That leaves a question as to whether there could be any weakness in the consumer credit sectors that could linger as inflation heats up.
Credit extensions are often a harbinger of this weakening. According Standard & Poor’s March 2022 US Auto Loan Tracker, the subprime extension rate declined month-over-month from 2.62% in February to 1.87%, and it also declined year-over-year. Tax refunds have a seasonal impact, but, even with inflation, S&P sees no “stress” in the extension numbers.
Lowell Sandell, corporate lawyer at Westlake Financial, notes that Westlake is currently seeing routine extensions more akin to “normal servicing of a loan on its way to maturity.”
Towards a new vision of subprimes?
With government stimulus measures ending and inflation rising, correctly identifying credit risk may require rethinking the factors that go into determining prime and subprime status. A LendingClub Study said 64% of people say they live paycheck to paycheck and nearly a quarter of them have FICO scores above 750.
Alternative data and artificial intelligence are available to help lenders understand these anomalies and make better credit decisions. According to Morgan, “Third-party data augments lending decisions and adds a ton of value when it can take into account more aspects of a borrower’s spending and payment habits.”
William Fife III, Chief Compliance Officer and General Counsel at Arivo Acceptance LLC, sees added benefits in alternative data because “it can help eliminate dealer fraud and can even get borrowers a lower rate because the lender has a better picture of risk factors.”
Subprime Automatic ABS Volume
The market view is that ratings agencies have been protecting auto asset-backed securities (ABS) investors well throughout the pandemic. “Credit enhancement has been healthy,” according to Sean Morgan. But he stresses that now “interest rates will be the thing to watch”.
Based on data from Finsight, there were 15 auto subprime ABS deals in the first quarter of 2022, on par with the first quarter of 2020. With 67 deals, 2021 hit an all-time high in volume. For comparison, there were 57 transactions in 2019.
But this level of activity is not expected to continue until 2022. Fitch Ratings predictionfor 2022 was “a neutral performance outlook” for ABS, expecting “losses and recovery rates to remain relatively stable in key sectors such as automotive and credit cards.” Fitch specifically expressed concern about subprime autos as being among the sectors that “would remain more susceptible to performance volatility given generally weaker borrower profiles.”
The The Wall Street Journal has previously reported on a pullback in the sector due to prices and wider spreads.
While the CFPB has adopted an increasingly aggressive tone in its bulletins, market participants we spoke with suggested that the CFPB does not always fully understand the practices they criticize.
Regarding the recent request from the Consumer Financial Protection Bureau (CFPB) concerns about repossessions, William Fife claims to have seen no rush into space to regain possession. “The CFPB may be using this passionate language to support its regulation with an enforcement approach.”
Additionally, Sean Morgan says that “there is no benefit to the repairer/lender with repossessions because you are locking in a loss”.
Fife suggests a change in collectors’ outlook. “For Arivo, we want to remove the word repossession from the vernacular of collections. We want to work on resolving issues to prevent repossession.”
With the collection modernization approach under Regulation F, Morgan says this change “helps limit outdated service practices and the transition to communication media that are more frequently used by borrowers.”
To help attendees prepare for and succeed in the new normal, I will be hosting a panel discussion at the National Automotive Finance Association Conference on non-priority automotive financing with Sean Morgan and Lowell Sandell of Westlake Financial and William Fife of Arivo Acceptance. We will discuss risks and opportunities arising from economic uncertainty, available technology and regulatory enforcement. ABS structures have historically protected investors, but there must always be strong fundamentals in origination and servicing. An informed discussion of the state of the market by these leaders will help identify best practices for maintaining success in the future.
Nicole Serratore, an associate in Davis+Gilbert’s Insolvency + Finance practice group, contributed to this post.
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