NEW YORK -
Near-term predictions made this week by Moody's Investors Service fall in line with ongoing lending cycle points noticed by veteran finance company executives such as Credit Acceptance’s Brett Roberts and Brad Bradley of Consumer Portfolio Services.
Moody’s analysts indicated in a new report that they do not expect losses of U.S. subprime auto loans to reach crisis levels. The firm acknowledged delinquencies have risen over the last few years, but they remain below the levels at the height of the financial crisis and have started to moderate.
Moody's senior vice president Mack Caldwell elaborated about that stance in the report, titled, “U.S. Subprime Auto Loan Delinquencies, Still Below Post-Crisis Highs, Reflect Typical Credit Expansion.”
Caldwell said, “Subprime auto lenders have already started to rein in lending to weaker credit-quality borrowers. Barring an imprudent expansion in lending to subprime borrowers, delinquencies will not increase to crisis levels.”
During their most recent quarterly conference calls, both Roberts and Bradley talked about the industry cycles both have seen in the subprime financing space. The finance company leaders each told Wall Street observers that their underwriting practices haven’t loosened in an attempt to chase volume — practices sometimes leveraged by other well-established institutions as well as start-up operations.
Bradley explained this is the third cycle of ups and downs in the subprime space since he’s been associated with CPS. Bradley also referenced what he called the second cycle — the span going into the last recession that he believes was “dominated by large banks.”
The CPS chairman, president and chief executive officer said, “Those large banks were able to compete very aggressively on price, caused a lot of independent players to really work hard and cut price and maybe buy more aggressively. All of those companies did just fine. We all went through it. I don't think anyone really particularly went out of business for credit reasons. A couple of people went out of business because they ran out of funding. That's a very distinct difference.”
Bradley went on to mention how much better finance company leadership is now as compared to lending cycles past.
“Almost all of the companies today are being run by people who have been in the industry for 25 years, as opposed to the first cycle where a bunch of the companies were run by people who had been in the industry for 5 minutes,” Bradley said.
“And so as much as you will have a few companies that don't do it particularly right, and a few of them fall on their face for a variety of different reasons, by and large the industry as a whole should do just fine,” he continued. “It’s run by better people. You’re going to have a few fall out, much like in the first cycle. But in terms of seeing this industry fall apart in any grand scale, it’s sort of hard to figure out why people would think that. It's run by more seasoned executives. There is no pricing pressure from banks.
“And in fact, we are sitting in one of the most favorable environments we possibly could be in,” Bradley went on to say.
In this week’s report, Moody’s emphasized the increase in financing to subprime customers marks the return to a typical consumer lending cycle. In recent months, Moody's contends that banks and other non-traditional finance companies have started to pull back from lending to subprime borrowers, which has eased pressure on the smaller finance companies that traditionally finance subprime auto loans.
With less competitive pressure, Caldwell insisted finance companies can target higher-credit-quality borrowers.
“Lenders have become more cautious, as evidenced by the rising credit scores of borrowers buying used vehicles," Caldwell said. “Subprime interest rates are also rising, a sign that lenders have a lower risk appetite.”
That slackening appetite is part of the typical cycle Roberts stressed to the investment community that he’s seen, as well. The Credit Acceptance CEO was asked to elaborate how contracts the competition might be adding to its portfolio might be influencing his company’s bottom line.
“The returns that we try to make, our target returns are quite a bit higher than the target returns of a lot of the companies we compete with,” Roberts said. “If everything goes according to plan, the profit per deal that we shoot to achieve is typically quite a bit higher in terms of returns. You can look at the other public companies that are out there that are auto finance companies, and compute their returns, and you can corroborate what I'm saying.
“But then usually there's a part of the cycle where things don't go according to plan,” he continued. “And because we have a nice margin of safety built into our business model, we typically do OK during those periods. There are other companies that operate with razor thin margins that don't do as well. We would expect it to play out the same way this time.”
Moody’s pointed out that delinquencies have risen with each full origination year since 2010. Analysts insisted the economic recovery and pent-up demand for vehicles spurred lenders to increase their loan volumes by extending credit to weaker borrowers.
Moody's vice president and senior analyst Peter McNally, a co-author of the report, also mentioned competition among finance companies increased to accommodate the pent-up demand, causing institutions to loosen underwriting standards.
“The potential for profits from subprime lending attracted banks, credit unions and captive finance companies, which typically do not focus heavily on subprime borrowers,” McNally said. “The average credit score on both used- and new-vehicle loans had declined and loan terms had lengthened, increasing the period in which a borrower could default.”
Moody's closed its report by noting analysts continue to be concerned over the long term about the operational risk in asset-backed securitizations backed by subprime auto loans from smaller lenders, which the firm’s ratings reflect.
“Increasing origination levels for small, niche players strain their ability to manage loan and transaction cash flows if they do not also increase servicing capacity, which can ultimately lead to higher losses,” McNally said.
“Higher loan losses can cause a financially strapped lender to lose investor confidence and funding, increasing the securitization’s losses if the servicer fails and a servicing transfer disrupts collections and loss remediation efforts,” he added.