Tricky road ahead for auto finance market

Auto manufacturers are on track for their best US sales year since 2006, but the growth of long-term loans, many to buyers with poor credit scores, and a surge of leased cars that will return to dealers by 2017, could create problems down the road.

Automakers sold almost 1.3 million new cars and trucks in October, an annual rate of 16.5 million, but this surge in business is down to three trends, any one of which could prove problematic, according to analysis in the Detroit Free Press.

First, the average length of a new car loan is now 67 months, the second-longest ever, according to Edmunds.com, which raises issues for purchasers who want to change cars before the term of their loan ends.

“The longer the car loan, the longer it takes to build equity,” said Gerri Detweiler, director of consumer education at Credit.com. “If you need to get rid of the car you may find yourself having to write a check just to get rid of it. Or even worse, you may be stuck in a scenario where you roll over that balance into another new vehicle loan, possibly at a higher interest rate.”

Second, leasing once again accounts for more than 25% of all new vehicle transactions, the highest level since the financial crisis. As a result, the number of cars returning from leases is expected to more than double from about 1.7 million last year to nearly 3.5 million in 2017, according to Manheim, the company that runs most of the auctions where dealers sell off-lease vehicles.

“We’re in for an extended period in which wholesale values (at the auctions) are going to fall,” said Tom Webb, chief economist for Manheim. “That’s not a good thing for the new car market.”

Finally, auto finance companies, banks and credit unions are approving more subprime loans to people with chequered credit histories, usually defined as borrowers with a credit score of 620 or lower.

Both the US Justice Department and the Securities and Exchange Commission are investigating the lending and securitization practices of GM Financial, Ally Financial and Santander Consumer USA Holdings.

Regulators are looking for evidence that subprime loans are being made with insufficient documentation of borrowers’ income and employment. They also are examining the expanding use of bonds backed by subprime auto loans. Those securitized loans have rebounded since 2011 and more of them are being issued in 2014 than any year since the financial crisis, according to a Wells Fargo research report released last month.

As well as the costs and risks of regulatory investigations, the delinquency rates on auto loans are trending up. A Citibank report released last month found that the delinquency rate on subprime auto loans rose to 3.8% in August from 3.2% a year earlier. In comparison, the delinquency rate on loans to prime borrowers was 0.4% in August.

However, the paper’s analysis concludes that automakers and their finance partners likely will be able to manage all these trends in the near term. They are borrowing money at very low interest rates. As they approve more subprime borrowers, those borrowers are paying high enough interest rates to keep the loans profitable.

The major players, such as Ally and GM Financial, JPMorgan Chase and Ford Credit, have become adept at repossessing cars when owners are delinquent for extended periods, a move which limits their losses.

Low interest rates, steady job growth and low gas prices are unlikely to change soon and are boosting auto sales. As a result, Emily Kolinski-Morris, Ford’s senior economist, predicts a growth rate of 3% going into the new year, and the company’s forecast is Americans will buy between 16.5 million and 17.2 million light vehicles next year, which will be better than this year’s high spot.