Subprime Credit Losses is Stressing the Auto Loan Market

The auto loan market is stressed. In the driver's quest to upgrade to a bigger, better model, more car buyers are purchasing new vehicles and rolling negative equity from previous loans into their new loan balances. The trend is one that will continue adding pressure to one of the most vulnerable pockets of the auto loan market, according to the latest report from Moody's.

Adding fuel to the fire, Fitch Ratings recently reported that U.S. auto loan and lease credit loss rates were weaker in the second half of 2016. Rates are expected to continue deteriorating.

"Subprime credit losses are accelerating faster than the prime segment, and this trend is likely to continue as a result of looser underwriting standards by lenders in recent years," said Michael Taiano, Fitch director.

Part of the problem, Moody's says, is that lenders are jumping on the "trade-in treadmill" by accepting rollovers from previous loans. Rollovers typically lead to mounting negative equity as drivers continue to purchase new cars.

Now that new car sales have plateaued and drivers have more options when it comes to financing, competition for the remaining loan supply will intensify. Drivers can now obtain loans not only through dealers but also on their own with the help of services like CreditLoan.

Fitch Ratings expects auto loan and lease credit performance to deteriorate in 2017.

Moody's says auto lenders are increasingly forced to be more accommodating in order to increase or sustain loan volumes. The trend is putting more pressure on auto lenders' balance sheets when negative equity at trade-in is at its highest level.

Along with the rollover option, lenders are also putting their balance sheets at risk by extending original loan terms.

Losses on subprime loans continues to accelerate. In January, losses jumped to 9.1% from 7.9% in January 2016. The 60-day delinquency rate for subprime is nearing the 6% mark, according to Business Insider.

Declining used vehicle prices is compounding the problem.

"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," Fitch said.

Prices for used vehicles declined 1.6% in February, marking the sharpest monthly decline since 2008.

Fitch speculates that an increase in new vehicle incentives and higher off-lease inventory may be driving the dip in prices. Both factors push down residual car values.

Tightening lending standards is also causing banks to lose share of the auto lending market. Credit unions and independent finance companies are filling the gap.

According to Fitch, credit unions and independent finance companies gained 25.4% and 20.5% market share respectively.

Still, Fitch says a strong economy could help offset the auto lending market's issues. Low levels of unemployment and increasing household wealth may restrict upward pressure on credit losses.

While unemployment continues to decline, consumer debt continues to climb, with growth in student loans, auto loans and credit card debt. Increased debt will weaken the borrower's ability to repay loans.