Subprime lending is not putting the auto finance industry at risk, but extended loan terms could be, a group of industry experts says in a new report.
Wells Fargo Securities compiled and released a report last week based on the state of the U.S. auto finance market. The bank hosted a panel of representatives from Group 1 Automotive, Cox Automotive, S&P Ratings Services, the National Automobile Dealers Association, Wells Fargo Dealer Services and Wells Fargo ABS Research.
Subprime auto lending is not a concern at this point of the business cycle, according to the report. Subprime made up about 22 percent of new- and used-vehicle loan and lease originations during the third quarter, Amy Martin, senior director and analytical leader of ABS at Standard & Poor’s, said in the report. That compares with a peak of 27 percent in the second quarter of 2005 during the last period of economic growth , according to Federal Reserve Bank of New York data. The low was 17 percent in the fourth quarter of 2009, the data.
But some subprime auto lenders have pulled back on the number of deals, which panelists said is “not a bad sign.”
With interest rates expected to rise as early as today and a stricter regulatory environment, independent finance companies that began or expanded lending in recent years may “struggle to maintain profitability,” the report said. But it added: “We think committed finance providers with scale are in a good position to gain share in the long term.”
Extended loan terms, on the other hand, could pose a problem for the auto finance industry, the report said.
Extended terms appear to be positive for the industry now because they enable consumers to buy a more expensive car and still keep monthly payments low, but they could become a drag down the road, the report said.
Average new-vehicle transaction prices are growing faster than household income, and regulations and consumer preferences, such as fuel efficiency, advance safety features and vehicle connectivity, add to the overall cost of a vehicle, the report said. With longer terms, the lender takes on more risk, and if the borrower defaults, the lender would have to sell the car at a greater loss than expected, Wells Fargo said.
Panelists also offered outlooks on the increase in used-vehicle inventories, pent-up demand and regulatory pressure.
The influx of off-lease vehicles will be manageable, and used-vehicle valuations “are expected to be moderate,” the report said.
The number of off-lease vehicles will increase steadily from 2016 to 2018, Tom Webb, chief economist at Cox’s Manheim unit, said in the report. He expects 2.5 million in 2015, 3.0 million in 2016, 3.5 million in 2017 and 4.0 million in 2018.
Sales of certified pre-owned vehicles are also expected to reach 2.5 million in 2015, which matches the number of vehicles coming off lease. Automakers’ “ability to underwrite leases effectively supports healthy CPO growth in the future,” the report said.
But panelists disagreed on the status of pent-up demand in the market, with some saying it’s close to being exhausted and others saying levels of pent-up consumer demand remain. They agreed it’s unlikely that 2015’s robust U.S. light-vehicle sales, on pace to break the all-time high of 17.4 million vehicles in 2000, will “reverse course” in 2016.
However, automakers may have to spend more on incentives to drive volume and lenders will take on more risk as loan terms grow.
The National Automobile Dealers Association also weighed in. NADA said that with regulatory changes in the market, there is “unnecessary uncertainty” around dealer financing regulation.