Signs of life in deep subprime lending

Deep subprime lending is finally in recovery mode.

"We have certainly seen a lot of growth; there are more loans to be had down in that area," said Melinda Zabritski, senior director of automotive credit for Experian Automotive.

Independent used-car lots and buy-here, pay-here dealerships probably account for the lion's share of deep subprime loans, analysts say. Still, new-car dealers do book deep subprime loans and also may own buy-here, pay-here stores or independent used-car lots.

"One of every three customers" has a credit score below 600. "That's not going anywhere," says Tim Tucker, who was general manager of used-car store Car Loans Express in Cincinnati until May 1 and is now special finance manager at Performance Honda in nearby Fairfield, Ohio. A credit score below 600 can put consumers in the riskier end of subprime, a category that starts at a score of 619, and even into deep subprime, a category defined as scores below 550, according to Experian's Scorex Plus scale.

Car Loans Express is the stand-alone used-car operation of new-car dealership Kings Ford in Cincinnati. Car Loans Express also has its own F&I department, which specializes in subprime financing.

Of the subprime risk tiers, deep subprime fell the most percentagewise during the recession, and it has been the slowest to recover, Experian data show. With some ups and downs, the less risky categories of subprime began to come back as early as 2010.

The deep subprime category accounted for 11 percent of all outstanding auto loans in the first quarter of 2013, up slightly from 10.7 percent a year earlier, Experian says. It was the first year-over-year share improvement for deep subprime since the first quarter of 2009, when the category reached its most recent peak of 15.7 percent of all outstanding loans. In terms of share, deep subprime is still down almost 30 percent from that peak.

Experian's Zabritski says that during the recession, lack of funding for subprime lenders was a bigger problem for the segment than lack of demand. "There has always been some financing available, even deep," she says. "Those consumers were not completely cut off. The lack of ability for the lenders to fund loans themselves was probably a bigger factor."

The credit freeze for asset-backed securities hit subprime lenders especially hard during the recession. Subprime lenders rely on the asset-backed securities market to sell off bundles of loans, to raise money to make new loans.

Today's asset-backed securities market is much friendlier to subprime lenders, says Amy Martin, senior director of Standard & Poor's Structured Finance Group in New York.

Through May 24, subprime auto lenders had raised $8.1 billion this year, or 31 percent of total U.S. retail auto loan asset-backed securities deals, she says. That was a dollar increase of 13 percent over the first five months of 2012. Subprime made up 24 percent of asset-backed securities deals for that year-ago period, Martin says.

She says that as more subprime lenders compete for business, competition from franchised dealers has cut into store traffic for buy-here, pay-here dealerships.

Tucker says the important thing is that lenders are back. He says that in his experience, per-unit profits are down because used cars are expensive and because bank fees are up but some dealerships are making it up on volume.

Six or so years ago, he says, used-car stores could make up to $3,000 profit on a vehicle, and now they are "lucky to make $1,400 to $1,800."

"That's fine," he says, "if you're doing 70 or 80 cars a month," as Car Loans Express was doing before he left. "But not if you're doing 20 or 30."