Sub-prime auto borrowing deteriorates

Sub-prime borrowers are showing signs of getting into trouble on auto loans, according to analysis based on the latest Quarterly Report on Household Debt and Credit from the New York Federal Bank’s Center for Microeconomic Data.

Economists who worked on the report have published an assessment in Liberty Street Economics commenting on the implications of the findings, which suggests that while mortgage balances continue to grow at a sluggish pace since the recession, auto loan balances are growing steadily. They argue this is partly fueled by high levels of originations across the spectrum of creditworthiness, including sub-prime loans, which are disproportionately originated by auto finance companies.

The dollar volume of originations has been high for all groups of borrowers this year, according to the data, with the quarterly levels of originations only just shy of the highs reached in 2005.

Sub-prime distress

Disaggregating delinquency rates by credit score reveals signs of distress for loans issued to sub-prime borrowers—those with a credit score under 620. Although it remains true that banks and credit unions comprise about half of the overall outstanding balance of newly originated loans, the vast majority of sub-prime loans are originated by auto finance companies.

The researchers estimate that of the $1.135 trillion of outstanding auto loans by credit score and lender type, 75% of the outstanding sub-prime loans were originated by finance companies.

According to the data, balances associated with the most creditworthy borrowers—those with a score above 760—have steadily increased, even through the Great Recession. Meanwhile, the balances of the sub-prime borrowers contracted sharply during the recession and then began growing in 2011, surpassing their pre-recession peak in 2015.

Delinquency rates

Auto loan delinquency data shows that the overall 90-plus day delinquency rate for auto loans increased only slightly in 2016 through the end of September to 3.6%. But the relatively stable delinquency rate masks diverging performance trends across the two types of lenders. Specifically, a worsening performance among auto loans issued by auto finance companies is masked by improvements in the delinquency rates of auto loans issued by banks and credit unions.

The 90-plus day delinquency rate for auto finance company loans worsened by a full percentage point over the past four quarters, while delinquency rates for bank and credit union auto loans have improved slightly. An even sharper divergence appears in the new flow into delinquency for loans broken out by the borrower’s credit score at origination, where the worsening in the delinquency rate of sub-prime auto loans is pronounced, with a notable increase during the past few years.

The researchers stress that it is worth noting that the majority of auto loans are still performing well, and emphasise that it is the sub-prime loans that heavily influence the delinquency rates. Consequently, auto finance companies that specialize in sub-prime lending, as well as some banks with higher sub-prime exposure are likely to have experienced declining performance in their auto loan portfolios.

The analysis concludes: “The data suggest some notable deterioration in the performance of subprime auto loans. This translates into a large number of households, with roughly six million individuals at least ninety days late on their auto loan payments. Even though the balances of subprime loans are somewhat smaller on average, the increased level of distress associated with subprime loan delinquencies is of significant concern, and likely to have ongoing consequences for affected households.