Auto lending landscape forecast to change

The overall U.S. new light-vehicle market looks fairly stable in 2018.

But even a modest rise in interest rates combined with tightening lending standards could bring changes to the auto financing landscape, panelists at the American Financial Services Association's Vehicle Finance Conference in Las Vegas said Tuesday.

Speaking a day before the Federal Reserve's Open Market Committee was widely expected to raise interest rates, Patrick Manzi, senior economist for NADA, forecast "three or four" rate hikes this year, for a combined increase of 80 basis points, or 0.8 percentage point. He predicted rate hikes totaling another 60 basis points in 2019. On Wednesday, the Fed raised rates and said it plans two more rate hikes in 2018.

On Wednesday, the Fed announced a rate hike, and forecast two more in 2018.

The increases won't affect buyers with good or excellent credit scores, Manzi said, but the "marginal buyer" with poor credit "is going to have to take that walk over to the used-car lot."

That's not necessarily a bad thing, he added, noting a growing surplus of off-lease used vehicles.

But Jeff Parent, president of distributor Gulf States Toyota, warned that rising rates could have other negative impacts.

For months, he said, automakers' "go-to marketing proposition" has been 0 percent interest-rate incentives. "If that's taken out of their quiver, they're going to have to go to cash" incentives if they don't reduce production fast enough to keep inventories in line with slowing sales, Parent said.

If inventories do start to balloon, he added, "expect to see dealers push back" against automakers' requests that dealership lots take on more cars and trucks, because higher interest rates will mean higher floorplanning expenses for dealerships.

Lenders have been tightening their credit standards for several quarters, speakers said.

In part that was because declining residuals — under pressure in part from the sheer volume of off-lease vehicles arriving on used-car lots — have made companies wary of what had been a rising share for leasing in the overall vehicle finance market, said Anil Goyal, executive vice president of operations for Black Book.

In addition, lenders have realized that longer loan terms have led to greater losses on loans, he said.

It's not that, in percentage terms, more loans are going sour. But on, say, an 84-month auto loan, very little of the first two years' payments go toward principal; most goes toward interest. So if a loan becomes delinquent within two years of origination, the lender is on the hook for more of the value of the car on an 84-month loan than on a 36-month loan.

But there are ways for lenders to mitigate that risk, Goyal said. For example, "with a lower [loan to value], you can go pretty confidently with a higher term." That could lead lenders to seek more money down on a financing contract.

Another way for lenders to limit risk is to stick to customers with credit scores rated prime and above. As those consumers discovered the deals available on off-lease vehicles, the percentage of used-vehicle buyers with prime credit scores increased in 2017.

That has left an opening for other lenders.

Brian Landau, automotive busines leader at TransUnion, said the reduced competition from major lenders brought new entrants in lending to nonprime consumers, particularly in used-car loans. Buy-here, pay-here dealers also see an opportunity for growth, he said. a