S&P Global Ratings took its turn on Tuesday to add more context to the headline-creating and social-media stirring auto-finance data released by the Federal Reserve Bank of New York. Credit analyst Amy Martin led the charge looking closely at subprime auto loan asset-backed security (ABS) market.
Martin acknowledged the New York Fed highlighted Equifax data that showed delinquencies were on the rise with 90-day delinquencies reaching 4.47 percent for the fourth quarter of 2018 and marking the highest level since the first quarter of 2012.
“Our outlook for subprime auto loan ABS is more sanguine than the delinquency increase may seem to imply,” Martin said in a report titled, “The Severity of Subprime Auto Loan Delinquencies Is in the Eye of the Beholder.”
“For one, our rating approach is very issuer-centric and generally focuses more on losses than delinquencies — and losses have risen at a much slower rate. To the extent we’ve observed deterioration in an issuer’s performance, credit enhancement (the cushion available to cover loan losses) is generally sized to take that into account,” continued Martin, a member of the initial collection of honorees for Women in Auto Finance showcased during Used Car Week 2018.
S&P Global Ratings shared the report with SubPrime Auto Finance News. The report detailed four causes higher delinquencies in the data analysts track, including:
— Growth in subprime originations during an intensely competitive period
— A composition shift to include more deep subprime financing
— Softer/gentler collection strategies
— Later repossessions and charge-offs by some finance companies
Analysts first delved into the origination growth happening in subprime.
“As the economic recovery was getting underway around 2010, existing lenders, most of which had tightened their credit standards during the recession, started to ease their lending parameters and grow originations. Also, many new players emerged, some funded with private equity,” S&P Global Ratings said in the report.
“As competition heated up, the discounts at which finance companies purchased auto loans from dealers started to evaporate, causing profit margins to thin. Some lenders responded by building scale, with their greater lending levels accompanied by weaker credit quality and higher delinquencies and losses,” the firm continued.
Next, analysts discussed the composition shift, pointing out that prior to the recession, there were few securitizers that catered to the deep subprime segment.
“That has since changed,” S&P Global Ratings said, reiterating that it defines deep subprime as those pools with cumulative net losses of 20 percent or more. The firm also noted that generally the contract holders in these pools have either no credit score or a FICO reading below 550.
S&P Global Ratings mentioned new securitizers in the deep subprime space include Santander through its DRIVE platform, American Credit Acceptance, Exeter Finance and J.D. Byrider (also known as CarNow Acceptance).
“With this growth in deep subprime lending, we believe there has been a shift where consumers with either no credit history or very derogatory ones are buying and financing their vehicles,” analysts said in the report. “When credit was scarce, many of these borrowers could purchase only a high-mileage used vehicle at either an independent used car dealership or a buy-here, pay-here lot.
“Given the plethora of subprime lenders today and the turndown programs between prime lenders and their subprime lending partners, some of these consumers can now buy new vehicles or low-mileage used vehicles at either new-vehicle franchise stores or large used-vehicle mega-dealership chains,” they continued.
Because deep subprime securitizations have grown to 38 percent of securitized subprime auto loans in 2018 from only about 11 percent in 2015, S&P Global Ratings explained that its monthly auto loan tracker data includes a modified index to normalize the composition.
The latest monthly update from S&P Global Ratings showed that subprime losses decreased to 9.58 percent in January from 10.15 percent in December and 9.98 percent in January of last year due to lower losses in Santander’s SDART and DRIVE transactions.
Analysts added January recoveries improved year-over-year, from 38.80 percent from 33.56 percent for subprime. S&P Global Ratings pointed out that last January’s subprime recovery rate was negatively affected by GM Financial’s servicing system upgrade.
And speaking of recoveries, that report titled, “The Severity of Subprime Auto Loan Delinquencies Is in the Eye of the Beholder,” continued by touching on more lenient collection policies used by some finance companies. S&P Global Ratings described them as “softer and gentler.”
In some cases, S&P Global Ratings acknowledged these changes are in response to increased regulatory oversight, which has shed light on alleged fair debt collection violations. These relaxed collection practices include calling the delinquent borrower fewer times, refraining from calling the borrower’s references and no longer calling the borrower’s place of employment upon his or her request.
“As a result, it sometimes takes longer to arrange a payment plan with the borrower or to locate the vehicle for possible repossession, thereby keeping the account in delinquency status longer,” analysts said in the report. “In other cases, greater tolerance for late payments is due to management supporting the practice that it’s better to keep a delinquent customer who is making payments (albeit late or only partial ones) than to repossess the obligor’s vehicle, which is likely to result in a higher severity of loss.
“Less aggressive collection practices have also contributed, in some cases, to higher extension rates,” they continued. “When granting extensions, however, most lenders do so in a manner that brings the delinquent obligor’s account current. If a delinquent obligor has, however, exhausted the lender’s maximum number of extensions, his/her account would likely be accounted for as delinquent.
“Further, there may be some situations in which an extension does not bring an account current,” they added.
With less intense collection practices, S&P Global Ratings is seeing later repossessions and charge-offs.
“In line with allowing customers more time to resume payments before repossessing vehicles, some lenders have lengthened the time that an account may be delinquent until it is charged off,” the firm said in its report.
“DriveTime did this at the end of 2011, and such action caused a significant rise in their 31-day delinquencies, to 17.9 percent at year-end 2012 from 11.20 percent a year earlier. That said, losses rose only marginally (to 14.0 percent from 13.2 percent),” S&P Global Ratings went on to say.
What do all of the trends and data points mean? Martin summed up the situation this way.
“Indeed, the weighted average expected cumulative net losses on the transactions we’ve rated have grown to approximately 20 percent in 2018 from 12.5 percent in
2011 and, at the same time, ‘AAA’ credit enhancement has increased to approximately 54 percent on a weighted average basis from 36 percent,” Martin said.
“As a result, our outlook for investment-grade subprime auto loan ABS ratings is in a better place than one might assume given the trend in delinquencies,” Martin went on to say while adding this report does not constitute a rating action.