NEW YORK -

S&P Global Ratings senior director Amy Martin recently assembled a report with a title that concisely summarized the current state of auto financing.

Martin’s analysis titled, “Speed Bump Ahead: As Auto Loans Accelerate Toward 84 Months, Caution Is Warranted,” reviewed data from Experian as well as a sample of six providers — a mix of captives and commercial banks — to arrive at a conclusion that might come as a relief to risk managers and other company executives.

Martin began with a noticeable, growing trend. The rising popularity of larger, more expensive vehicles and new vehicle technology has driven growth in the average transaction price and amount financed of new vehicles. She explained higher financed amounts coupled with increased borrowing costs are fueling upward pressure on monthly payments, creating an affordability issue for consumers.

As a result, auto finance companies have been addressing this concern by lengthening contract terms, which serve to lower monthly payments. Experian’s second-quarter information showed terms lasting 61 to 72 months remain the most common (40% of new and 44% of used-vehicle contracts). However, Experian also determined contracts with an original term of 73 to 84 months have grown to approximately 31% and 19% of all new and used vehicle contracts, respectively.

S&P Global Ratings also discovered this year marked the first time a U.S. captive finance company securitized 84-month loans in a public U.S. ABS term transaction.

“These longer-term loans pose additional risk to investors and can lead to higher cumulative net losses (CNLs),” Martin said in the report shared with SubPrime Auto Finance News. “As loan terms lengthen, their principal balances amortize more slowly, and loss severity escalates.

To measure the degree to which longer-term loans have higher losses than their shorter-term counterparts, Martin and S&P Global Ratings analyzed the origination static pool net loss data of three prime auto issuers from 2008 through 2014 and found that, on average, CNLs were more than four times higher for contracts with terms in the 73-month to 84-month range than those with terms of less than or equal to 60 months.

As the presence of longer-term loans increases in U.S. auto loan securitizations, S&P Global Ratings acknowledged that it may adjust its expected CNL levels upward, which could result in higher credit enhancement levels.

Martin wrapped up her analysts by emphasizing the lengthening of contract terms, while a risk, is a manageable one that can be addressed in a number of ways.

“First, the portion of longer-term loans can be limited, especially if the issuer has a short track record of making these loans,” Martin said in the report. “We saw this when 72-month loans became the industry standard. In general, lenders slowly added these to their pools, many keeping the percentage in a range of 10%-15%.

“In addition, credit enhancement can address the higher risk associated with these loans,” she continued. “Finally, today's environment is similar to the early 1990s when loan terms lengthened to 60 months from 48 months, and 2001 when they started to stretch to 72 months. At the same time, vehicles are lasting longer than they did 20-25 years ago, with many still on the road after 10 years.

“The auto finance and auto loan ABS market survived the earlier lengthening of loan terms, and we believe it will weather the evolution to 84 months, although it’s not a welcomed trend,” Martin concluded.

The entire report can be downloaded here.