Manheim Analyzes Auto Financing Industry’s Health
ATLANTA — Manheim addressed financial-market health in its 2008 Used-Car Market Report, including discussing the market instability in 2007 driven by the subprime mortgage downfall, the impact of this on the auto sector and what the future may bring.
Overall, the report reassured the industry that the auto lending arena remains stable, despite credit-market tightening; however, it did caution financial institutions to be cautious in their growth and remain true to previously learned lending/underwriting principles to remain profitable.
While the auto financing sector as a whole continues to thrive, albeit more reservedly, market analysts indicated that the impact of the subprime meltdown will be ongoing for 2008, and perhaps beyond.
Impact of Subprime Mortgage Woes on Auto Industry
Kicking it off, Manheim discussed the credit instability that hit the market in the summer of last year, indicating that the lingering effects continue to impact the economy and auto industry in 2008.
"In early August 2007, the long-feared spillover of subprime mortgage problems into the broader credit market occurred with a vengeance," officials described. "Surprisingly, or maybe not so surprisingly in this age of global finance, European banks were the first to scramble for cash as their overexposure to subprime mortgages and derivative instruments became clear.
"That panic jumped the Atlantic the same day, and in the ensuing weeks, Federal Reserve officials and banking executives discussed and wrestled to create solutions that could restore stability," executives continued.
The resulting actions were that the Federal Reserve moved quickly to reassure the financial community and instituted various rate cuts.
"From mid-August 2007 to mid-January 2008, the federal funds' target rate was reduced from 5.25 percent to 3.50 percent. The steepness of this decline is almost unprecedented," Manheim pointed out.
"Although residual weakness in the credit market remained at year-end, a full collapse (which was closer than most Americans knew) was avoided. Given that credit availability is the life-blood of both the new- and used-vehicle sales markets, things could have been much worse in our industry," analysts explained.
"Cost and availability of credit is key to retail used-vehicle sales. It was heartening, therefore, that the retail auto financing market functioned well throughout 2007, even while there was great turmoil, stress and volatility in the broader credit market overall," the market overview attested.
As several subprime mortgage lenders drown in their credit problems, investment analysts appeared to turn their speculation on the subprime auto industry to see if it would follow suit.
"What they found, however, was an industry with solid management and a well-developed business model," Manheim's Used-Car Market Report found. "Consider, for example, the key reasons why many subprime mortgages failed and contrast that with auto lending."
In the "glory days" of the mortgage broker arena, "no documentation and no down payment" became typical. The company described the mortgage sector as in its "infancy," with many players thinking underlying collateral, or the home, would grow in value quickly, offsetting risk.
"In contrast, subprime auto lending is a mature industry where the lenders have gone through previous credit cycles and learned from the experience," the company pointed out. "Sometimes, auto lenders will aggressively go after business, but they never completely throw out their scoring models."
Identifying one of the key problems in the mortgage sector, Manheim pointed to the brokers, who generally had no stake in the loan success.
"Their objective (compensation) was based on simply doing deals — even loans that had no hope of ever being repaid," officials explained. "On the auto-lending side, dealers, F&I managers and lenders have long-established practices that reinforce (and compensate) mutual success."
Low teaser rates and payment-option mortgages easily caused issues with consumers when climbing interest rates and depreciating home values cut off homeowners from any other option but to default.
"Unlike mortgage lenders, auto lenders never delude themselves into thinking the underlying collateral will rise in value and, thus, make even a bad loan good. And when it becomes necessary to liquidate the collateral, auto finance companies have, in the form of auctions, a mechanism to quickly realize market value," executives described.
When it comes to homes, market value is a much more subjective term, depending on the volume of foreclosures, the regions they are located in and housing demand.
"In contrast, a rise in auto repossessions has only a marginal impact on vehicle values, given that the wholesale market is so large and liquid," Manheim highlighted.
And yet despite these factors, Manheim said, "However, having sound business practices does not make auto lenders totally immune to the broader forces in the credit markets. Because of the stress in the credit markets in late 2007 (and also due to weaker household finances), auto lenders (across the spectrum) felt it prudent to lower permissible loan-to-value and payment-to-income ratios and accept any slowing in originations those actions might produce.
"This had, and will have, a dampening effect on the retail used-vehicle market in the short term, but it should ensure healthy credit availability over the longer term," executives wrote.
Overall Credit Industry
According to Manheim's analysis, more than $450 billion new- and used-vehicle loans were written last year, ranging the entire credit spectrum.
From 2002, the company said that term length has been increasing. More specifically, by 2007, 41 percent of securitized prime auto loans had terms greater than 60 months, up from 12 percent five years ago.
As for securitized subprime loans, those with terms greater than 60 months jumped to 67 percent from 33 percent in 2002.
"For lenders, the implications of longer-term loans are generally not positive," Manheim indicated. "Longer loans result in slower principal repayment and can cause a greater severity of loss on repossessions. Additionally, the longer borrowers remain in negative equity, the more likely they will simply walk on the loan."
Additionally, executives explained, "Even absent a repossession, a greater frequency and magnitude of negative equity can slow sales, reduce the amount available for future down payments, or lower overall credit standards."
However, the industry found it hard to resist lengthening loan terms, as it makes the monthly payment more attractive for customers, not to mention the need to compete with other lenders.
Now that vehicle age has increased, Manheim noted that this move toward longer loans may not be quite as risky as it was in the past. That is, if it is done correctly, of course.
The report also shared some collateral trends, based on data from Standard & Poor's:
Weighted Average FICO: 713
Percentage of Original Maturity Greater Than 60 Months: 40.92 percent
Percentage Used: 21.61 percent
Weighted Average APR: 5.46 percent
Weighted Average FICO: 716
Percentage of Original Maturity Greater Than 60 Months: 38.56 percent
Percentage Used: 21.98 percent
Weighted Average APR: 5.68 percent
Weighted Average FICO: 719
Percentage of Original Maturity Greater Than 60 Months: 31.61 percent
Percentage Used: 24.62 percent
Weighted Average APR: 5.79 percent
Weighted Average FICO: 655
Percentage of Original Maturity Greater Than 60 Months: 81.41 percent
Percentage Used: 66.50 percent
Weighted Average APR: 9.69 percent
Weighted Average FICO: 654
Percentage of Original Maturity Greater Than 60 Months: 66.17 percent
Percentage Used: 55.11 percent
Weighted Average APR: 11.43 percent
Weighted Average FICO: 650
Percentage of Original Maturity Greater Than 60 Months: 56.35 percent
Percentage Used: 62.01 percent
Weighted Average APR: 10.81 percent
Weighted Average FICO: 601
Percentage of Original Maturity Greater Than 60 Months: 67.25 percent
Percentage Used: 73.59 percent
Weighted Average APR: 15.56 percent
Weighted Average FICO: 591
Percentage of Original Maturity Greater Than 60 Months: 52.50 percent
Percentage Used: 63.57 percent
Weighted Average APR: 14.95 percent
Weighted Average FICO: 592
Percentage of Original Maturity Greater Than 60 Months: 52.60 percent
Percentage Used: 63.57 percent
Weighted Average APR: 14.95 percent
Delinquencies and Repossessions
The fallout in the mortgage industry ramped up pressure on consumer finances, ultimately leading auto delinquency rates to climb, which in turn led to an increase in the number of repossessions.
In fact, Manheim reported that total repossessed vehicles grew 10 percent over 2006.
"Delinquency rates did, however, uptick as the year progressed, reflecting the slower labor market and the tremendous pressure placed on household finances by higher gas prices, mortgage rate resets and the weight of past debt obligations," the company said.
Overall, no particular type of vehicle was more widely impacted than another.
"The repossessed vehicles sold at auction could have come from a prime, new-vehicle contract on a high-end luxury car that went bad early in the term, from a subprime loan on a low-end vehicle that defaulted late in the term, or anything in between. As such, repossessions at auction represent of wide mix with respect to model, age, mileage, condition and price," the market analysts attested.
Auto Lender and Auction Partnerships
Manheim's Used-Car Market Report also pointed out that many lenders have tended to work with franchised dealers over the years, and are, interestingly enough, now seeking out relationships with independent dealers.
"Auctions are uniquely positioned to help here, given their daily interaction with thousands of independent dealers," officials stated.
Real-time pricing information from auctions can also assist auto lenders in setting realistic loan-to-value ratios, or explain how certain types of vehicles and styles are performing at auction.
"And, since auction pricing is recognized as representing true market conditions, lenders use that information in their communications with the investment community," Manheim explained. "For example, several lenders cite the Manheim Used Vehicle Value Index in their SEC filings to provide analysts and shareholders with a perspective on overall used-vehicle pricing conditions."
Moreover, the report went on to indicate, "Together, auctions and lenders can also make strategic decisions to improve remarketing performance.
"For example, Manheim can help lenders with only a few repossessions, or repossessions geographically dispersed, combining their vehicles with those of other lenders in special, highly marketed sales events," the company concluded.