Car sales in America have hit the brakes recently after a period of record sales.

Much of the growth in auto sales has been stimulated by expanding car loan volumes which now sit at over $1.1 trillion in car loan debt outstanding, 40% above 2008 levels.

As auto lending volumes have expanded, delinquency and loss rates on car loans have also begun to increase, particularly in the high risk, sub-prime sector.

With rising interest rates and tightening credit standards set to impact the US, will the car finance industry face similar pressures here in Australia? 

The overall auto loan market in the US is now over $1.1 trillion in debt outstanding, 40% above 2008 levels.

A degree of trepidation has creep back into the US markets as investors worry about negative signs starting to take hold in to car loan market that could lead to fewer car sales.

According to Autodata, US vehicle sales ran at a seasonally adjusted annual rate of 16.6 million in March 2017, down from February's 17.6 million-vehicle pace, and well below the 18.5 million rate reached in December. What's worrying is that sales have slowed even though car makers have been discounting prices aggressively and finance companies continue to originate large levels of higher risk car loans.

Non-prime auto lending in the US has remained relatively robust, with over $110bn in originations in 2016 for borrowers with credit scores below 620, a cutoff commonly signifying “subprime”. The overall auto loan market in the US is now over $1.1tn in debt outstanding, 40% above 2008 levels..

Delinquencies and default rates are climbing in the Auto ABS sector. While these metrics have not yet deteriorated as far as they did during the financial crisis, the YoY increases are meaningful, especially coming at a time when the rest of the consumer balance sheet – outside of US student loans – appears to be performing well.

The cracks in fundamentals can be partly attributed to the shift-in-mix of origination share away from lenders with stronger borrower profiles (like Honda Financial Services, Toyota Financial Services, VWFS, Nissna Finance and BMW) to credit providers that focus on car loan borrowers with lower credit scores.

Some issuers have lower underwriting criteria and the share of Auto ABS originated by these issuers is trending higher.

As auto lending volumes have expanded, delinquency and loss rates on auto loans have also begun to increase. Aggregate loss rates for auto asset backed securities (ABS) have also been picking up.

Does this deterioration in auto loan performance reflect broader problems with the US consumer and US economy? We think the answer is no; rather, we see rising auto loan loss rates as more reflective of conditions specific to the auto loan sector. Specifically, the higher loss rates are largely a reflection of a loosening of underwriting standards for car lending in America.

The increase in auto loan delinquency rates is an important trend to monitor, but we do not think it represents a source of significant systemic risk.

Whilst aggregate auto loan delinquency rates – including prime, subprime and deep subprime loans – are rising, they are still well below delinquency rates on credit cards.

The lower default rates on auto loans reflects the fact that borrowers frequently tend to prioritise auto loan payments ahead of other accounts.

Investors, many of whom suffered hefty losses during the subprime mortgage crisis, persuaded themselves that bonds backed by car loans were much safer than bonds backed by home loans. That's because cars are easy to repossess if borrowers stop making their loan repayments, unlike houses where the foreclosure process can take years. The strong demand for used cars meant that seized cars could easily be resold, complete with a new financing package.

But their optimism is fading as car prices fall and delinquent car loans have climbed to levels not seen in more than eight years. According to recent figures from the New York Fed, US car delinquency rates are deteriorating, with the number of delinquent loans – where borrowers are 90 days or more behind in their repayments – climbing to 3.8 per cent of all car loans outstanding by the end of last year.

Some analysts argue that rising delinquency rates are not a cause for concern. After all, car loans account for less than 10 per cent of the $US12.6 trillion ($16.6 trillion) owed by US households, and so problems in this segment are unlikely to cause wider market contagion.

But others argue that the investors growing wariness of high yield bonds backed by car loans could spread through the broader junk bond market, which could then spread to other markets. After all, stresses in the US junk bond market in late 2015 preceded a broader global sharemarket meltdown in early 2016.

As a consequence of these developments in the US auto market, AFS believes these emerging trends will be cause for concern here in Australia given the conservative nature of domestic auto lenders and the Australian ABS market.

Potential reaction by Australian car financiers include:

  • increased delivery rate for borrowers as investors factor risk into the yield curve;
  • tightening of credit policies by lenders due to increased capital requirements;
  • increasing geographic restrictions to lending into high risk postcodes and suburbs; and
  • increasing deposits and shortening of terms for marginal credit applications to mitigate delinquency risk.

Other forces at play that will impact lending standards in the near future are:

  • the introduction by APRA of APS120 on 1st January 2018 that increases the capital requirement for most securitisation structures;
  • ban on flex commissions by dealers that commences 1st September 2018; and
  • proposed ban on the financing of add-on insurances at the point of sale of a car.;

Further updates on these matters will be provided over the coming months. 


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