Subprime Lenders In Hot Water As Dealerships Close

New vehicle transaction data from Edmunds reveals that record-breaking automotive financing figures from Q1 were unyielding in the second quarter. The share of consumers who financed a vehicle with a monthly payment of $1,000 or more reached a new all-time peak of 17.1% in Q2, up from 16.8% in Q1 2023 and 4.3% in Q2 of 2019.

Meanwhile, Average monthly payments also reached a new record high of $733 in Q2, up from $678 in Q2 2022, and the average APR was 7%, up from 5% in Q2 2022. Of the borrowers paying $1000+ per month, 64.5% signed up for an average loan-term range of between 67 and 84 months and an average APR of between 8.5% and 9.6%.

A thousand dollars is roughly 25% of pretax monthly wages for the average 25- to 34-year-old, and the average person in that age range might not be able to afford that.

“The double whammy of relentlessly high vehicle pricing and daunting borrowing costs is presenting significant challenges for shoppers in today’s car market,” said Ivan Drury, Edmunds’ director of insights, in a news release. “The Federal Reserve’s recent pause in interest rate hikes, unfortunately, didn’t offer much relief for consumers, and hints at further raises later this year mean auto-loan rates could even continue to increase.”

Edmunds analysts say this group is made up of consumers who are paying thousands of dollars toward interest against principle, and could find themselves upside down on their auto loans down the road.

Delinquencies Hit Banks

This year, US consumers have fallen behind on their personal loan and credit card payments at the highest rates since 2010. Americans took out a record $87.5 million in new credit cards and $22.1 million in personal loans in 2022, according to a report from TransUnion.

Last year, the share of borrowers 60 or more days delinquent on their auto loan payments was 26.7% higher in December than it was a year earlier, although the total proportion was only 1.84%. But in the subprime category, the share of consumers 60 or more days delinquent rose to 6% in December.

Now, bonds backed by car loans made by U.S. Auto Sales and American Car Center, two used-car dealers that shut their doors earlier this year, have been veering into distress in recent weeks.

In February, national subprime car dealer and loan-originator American Car Center told employees the business was closing its doors. Before the announcement, American Car Center had shelved a bond deal backed by subprime loans, citing market conditions despite investors placing orders for the debt.

And in April, U.S. Auto Sales, a car dealer that catered to subprime and deeply subprime consumers, closed its dealerships too.

U.S. Auto Sales often turned to bond markets to raise capital, packaging subprime auto loans it originated into asset backed securities, most recently raising a $233 million bond in June of last year. Loans within that bond fell on the lower end of the credit spectrum, coming from borrowers with average FICO scores of 518.

On average those borrowers had taken out loans worth more than 150% of the vehicles, with an average principal balance of $20,199 and an 18% interest rate, a report from Kroll Bond Rating Agency showed.

Any lost principal would be a rare event in the ABS market, where subprime auto bonds haven’t failed to return investors’ money since the 1990s, Citigroup said to Bloomberg.

Prices on a bond issued by U.S. Auto Sales, owned by private equity firm Milestone Partners, have dropped to distressed levels, trading at a little over 18 cents on the dollar on June 26.

Used Car Bubble

One of the reasons auto ABS losses are almost unheard of is the use of investor protections known as overcollateralization. That means the amount of loans backing the bonds exceeds the size of the principal on the bonds, allowing at least some borrowers to default without any losses for bondholders.

But for the two subprime issuers that ran into difficulties this year, those protections have waned dramatically on some securities. The overcollateralization for the 2022 U.S. Auto bond has fallen to just 5.5%, compared with a target of 35%, according to a Citigroup report dated June 30.

Used vehicle prices skyrocketed during the pandemic. Between July 2020 and July 2022 new car prices increased by about 20 percent but used car prices increased by about 40 percent.

Those increases drove up borrowing activity sharply, especially among people with low credit scores who predominantly buy used cars, rather than new ones, an analysis by the Consumer Financial Protection Bureau (CFPB) found.

“One might expect that, since consumers with deep subprime credit scores likely have the least financial cushion to absorb higher vehicle prices, they might have responded to recent price increases by buying less expensive vehicles,” says the report.

But researchers from the Federal Reserve Bank of New York found no evidence using credit bureau data that consumers were responding to higher prices by purchasing fewer vehicles during the pandemic. The median value of vehicles purchased by consumers with prime credit scores has increased by about 30 percent since 2019. For consumers with deep subprime credit scores, it has increased by about 60 percent.

Repossessions

Down the line, collateralization takes the strongest hit. As overpriced vehicles depreciate at higher rates than normal, both lenders and borrowers quickly go underwater. And, if a lender is forced to repossess a vehicle and sell it at auction, they may lose thousands of dollars on the charged-off loan.

Last June, Barron's reported vehicle repossessions were on the rise. According to data from the National Automotive Finance Association, subprime repossessions have nearly doubled since 2020, to around 11% on average.

Barron's also interviewed car dealers who regularly purchase repossessed vehicles before they head to auction. One noted that the repossessed cars are coming out of situations where the buyer's loan-to-value ratio is trending well north of 100%

U.S Auto Sales’ subprime loans were not an anomaly. Loan-to-value ratios, or the amount financed relative to the value of the vehicle, were around 140% in 2021, versus a more normal 80%; and many of the loans were extended to buyers who had temporary pops in income during the pandemic.

As Danielle DiMartino Booth, CEO of Quill Intelligence noted, companies in the business of repossessing autos are among the first to know when economic trouble is brewing. And now those companies are buying car lots to handle the flood of repossessed used vehicles.

Black Book, a research company founded in 1955 that specializes in automotive valuations and wholesale economics, noted that all 22 vehicle segments are softening in price at auction, leading to an overall value drop of 0.44% while the estimated average weekly sales rate remains steady at 46%, down from nearly 75% in Q2 2021.