Wall Street is starting to worry about the auto loan market.
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.
The increased interest in the auto loan market seems to be based on commentary from Ally Financial, weak 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 dropping 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 showing signs of stress.
- A growing proportion of the auto loan ABS market is now made up of "deep subprime" deals.
To the charts:
Fitch: "Deteriorating credit performance will be more acute in the subprime segment."
The 60+ day delinquency rate for subprime is at the highest in at least seven years, according to Fitch.
Previously, Steven Ricchiuto, Mizuho's chief US economist, highlighted a jump in losses on subprime auto loans, moving to 9.1% in January, up from 7.9% in January 2016.
And in November, the New York Fed's Liberty Street Economics blog looked at the deteriorating performance of subprime auto loans and set off the alarm.
"The data suggest some notable deterioration in the performance of subprime auto loans. This translates into a large number of households, with roughly 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 show signs of pulling back.
"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. The increase for finance companies was especially striking, with this group moving from 18.9% to 20.5% in 12 months.
Fitch highlighted the impact auto finance companies were having on the market:
"Fitch expects that deteriorating credit performance 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."
Meanwhile, used vehicle values are falling.
"NADA's Used Vehicle Price Index, which measures wholesale prices of used vehicles up to eight years old, declined over 6% in 2016 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 2008 and a seasonal anomaly for February."
Evercore ISI: There was a "sharp deterioration in the auction performance across all of Ford’s deals" from the summer of last year onwards.
The sharp 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:
The development at Ford is aligned with details provided by the company. Interestingly, Ford Credit CFO Marion Harris remarked that "lower values... are not a reflection of demand, they really are just a [result of] supply". 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 a Truck 1 for $100, taking out a $80 loan to make the purchase.
- Truck 1 drops in value by half by the time Car Buyer decides to trade in.
- In that time, Car Buyer has only paid $10 of the loan, leaving him/her with $20 in negative equity ($80 loan minus $10 payment minus $50 trade-in)
- Car Buyer rolls the $20 negative equity in to the next loan on the next purchase.
From Moody's note:
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 "trade-in treadmill" generates higher loan to value ratios, slower principal amortization and higher loss severity when defaults occur.
Morgan Stanley: "Across prime and subprime ABS, 60+ delinquencies are currently printing at 0.54% and 4.51%, respectively, with the latter approaching crisis-era peak levels (4.69%)."
Asset-backed securities based on auto loans are showing signs of stress, with the subprime auto ABS delinquency rate closing in on crisis-era peak levels.
Here's Morgan Stanley:
"Across prime and subprime ABS, 60+ delinquencies are currently printing at 0.54% and 4.51%, respectively, with the latter approaching crisis-era peak levels (4.69%). Default rates are also picking up in similar fashion (prime: 1.52% ; subprime: 11.96%), printing close to crisis levels. While prime severities slowly 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 heavily weighted toward deals that we would consider deep subprime."
A key driver of the increasing delinquency rate is a spike in the proportion of "deep subprime" deals, or those with an average FICO score of less than 500.
Here's Morgan Stanley:
"The securitization market has become more heavily 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 ABS origination that has come from these deep subprime deals has increased from 5.1% to 32.5%. This growth has been augmented, if only slightly, by the emergence of new deep subprime lenders - those who had not issued a deal before 2012."