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Balancing Act

We hate to burst your bubble, but there is no bubble to burst. Auto finance expert breaks down the third-quarter results.

January 2017, F&I and Showroom - Feature

by Melinda Zabritski

For anyone worried by doomsday predictions about a subprime bubble in the auto industry, the third quarter of 2016 provided a welcome reality check. Delinquencies rose slightly, but lenders reacted accordingly by rebalancing their loan portfolios, reducing their total share of subprime and deep-subprime loans.

Overall, the automotive loan market remained quite robust in the third quarter, as the total dollar value of all auto loans grew to $1.055 trillion. As for what drove that growth, credit unions realized significant gains in originations during the period due to consumer demand for competitive interest rates.

One trend worth mentioning: Auto loans for used vehicles are making headway within the prime and superprime risk tiers, as new-vehicle prices, monthly payments and loan dollar amounts continue to grow year over year. Here’s a closer look at some of the trends that shaped the automotive finance industry in the third quarter.

Loan Dollar Volume Reaches Record High

At $1.055 trillion, total loan balances grew by $87 billion from a year ago and by $135 billion from the third quarter of 2014. Banks led the way with a loan balance of $358 billion, up $27 billion from a year ago. Credit unions grew their balances by $35 billion to $269 billion, surpassing captive finance companies to become the second largest automotive portfolio in the third quarter.

All other lending types experienced strong growth as well, with finance companies and captives growing their balances by $17 billion and $8 billion to $178 billion to $250 billion during the period, respectively.

Rate Uptick a boon for Credit Unions

Perhaps the biggest shift was the growth in market share for credit unions, with the segment capturing 19.6% of the market. That’s up from 17.6% in the third quarter of 2015. Much of that growth was driven by the segment’s activity in the new-vehicle space, where it grew its share by 22% from a year ago to 12%.

Another key driver of the segment’s market share gains was the increase in interest rates, which, for the average new-vehicle loan, rose from 4.63% in year-ago quarter to 4.69%. Credit unions typically offer the most competitive rates, so it’s natural to see a rise in credit union share anytime rates jump.

Pushing car buyers toward credit unions even more were the continued rise in vehicle prices and finance amounts, making the segment an attractive option for shoppers looking for payment relief.

30-Day Delinquencies Flat, 60-Day Rate Rises

Delinquencies are an important measure of loan market stability, and car buyers continue to make their payments in a relatively timely fashion. Overall, 30-day delinquencies in the third quarter were flat from a year ago at 2.38%. However, banks (1.96% to 1.97%), captive finance companies (2.18% to 2.22%), and credit unions (1.33% to 1.38%) all saw their 30-day delinquency rates rise.

Finance companies, which typically provide a higher percentage of loans to riskier customers, experienced a significant drop in delinquencies. The segment’s 30-day delinquency rate fell from 4.83% in the year-ago quarter to 4.58%.

Sixty-day delinquencies, however, showed an uptick across the board, with the rate rising from 0.67% in the year-ago quarter to 0.74%. The 60-day rate for banks rose from 0.58% to 0.63%, while the rate for captives moved from 0.41% to 0.5%. The 60-day delinquency rate for credit unions increased from 0.33% to 0.34%, while the rate for finance companies increased from 1.73% to 1.78%.

Share of High-Risk Loans Drops

As 60-day delinquencies rose, finance sources took corrective action and reduced their overall share of subprime and deep-subprime loans. The combined subprime and deep-subprime share of all auto loans dropped from 23.59% in the year-ago quarter to 22.74% in the third quarter.

Credit scores also fell during the period, as finance sources shifted to slightly more conservative strategies. In fact, the move to more prime and superprime customers pushed year-over-year average loan scores higher for the first time in four years.

For new-vehicle loans, the average score increased two points from a year ago to 712. For used-vehicle loans, the average credit score jumped five points from a year ago to 655.

Low-Risk Borrowers Shifting to Used

The increase in used-vehicle credit scores was also the result of low-risk borrowers shifting toward that segment, as they looked for ways to manage vehicle costs. That trend benefited franchised dealers, who saw their share of used-vehicle loans made to prime and superprime customers grow from 55.8% in the year-ago quarter to 57.62%.

Independent dealers also benefited, as their prime and superprime loan share grew from 28.94% in the year-ago quarter to 33.81%.

Rational Confidence Is Key to Sustained Stability

Since the slow but steady rebound from the recent recession, the automotive finance market has shown remarkable stability. After severely tightening credit during that recessionary period, finance sources have ventured deeper — little by little — into the subprime end of the lending spectrum. Many industry observers wondered how long average credit scores would continue to drop. Well, they now have their answer.

However, the move to slightly tighten credit in the third quarter is a positive sign for the industry and the economy. It’s simply rational behavior on the part of finance sources. Tightening too much might choke off sales. But ratcheting back by just a few percentage points on subprime and deep-subprime financing will continue to keep a subprime bubble from forming while allowing finance sources to continue greasing the engine of commerce in a sustainable manner.

Melinda Zabritski serves as senior director of automotive credit for Experian Automotive. Email her at melinda.zabritski@bobit.com.

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