I love when the National Automobile Dealers Association convention takes place in Las Vegas, as it did this year. Though I’m much more inclined to spend my time in Las Vegas taking in a show, I like the sensory overload of a walk down the strip or a stroll through a casino. I like the bright lights, the bells and the dings of the slot machines, the clicking of the chips and the sporadic cheers of people at the craps table when someone rolls a seven.
Obviously, when people think of Las Vegas, they think about gambling. Unfortunately, I’m starting to think that subprime financing is developing a similar connotation. There are some people who see the word subprime next to an increase in loans and recoil, thinking about the pain from the financial market meltdown just a few years ago. Much of the real-estate crash revolved around subprime loans, and it seems subprime auto loans are guilty by association. In reality, when lenders drop into the subprime category, it can be very beneficial to dealers, as it opens potential sales to many more customers.
In Q3 2011, share of loans to sub-prime customers overall was up by 3.18% since Q3 2010, from 36.71% to 39.89%. However, this doesn’t necessarily mean the industry should be alarmed. As long as it is managed correctly, a little bit of risk can be good.
When automotive lenders have healthy loan portfolios, with low delinquency rates and lower dollar volumes at risk, they are free to adjust loan criteria for down payment, term and loan-to-value ratio and to make more loans to riskier customers. As long as lenders carefully monitor loan performance relative to delinquencies and dollar volume at risk, subprime auto loans can work well.
A couple of years ago, when automotive lenders started to see higher delinquency rates and had high dollar volumes at risk, it limited their options in terms of how much they could push the envelope with their loan strategies. They wisely began focusing their loans mainly on customers with strong credit.
In Q3 2009, nearly a year after lending markets froze average credit scores for new vehicle loans peaked at 775, up from 749 in Q3 2007. In part, this was because subprime lenders did not have access to adequate capital. It also was a reaction by other lenders to a significant rise in automotive delinquencies. In Q3 2011, the 30-day delinquency rate was 3.27%. However, by Q3 2011, this rate had dropped by 14.9% to 2.78%. Total dollar volume of at-risk loans dropped by more than $9.4 billion from Q3 2009 to Q3 2011.
With fewer loans and dollars at risk, lenders felt comfortable opening more loans to subprime customers. The average customer credit score for new car loans dropped from the Q3 2009 high of 775 down to 763 in Q3 2011. In addition, the average dollar amount for a new vehicle has grown. In Q3 2010, the average new vehicle loan was for $25,273. This increased to $25,873 by Q3 2011.
The appetite for larger loans was prevalent in the nonprime, subprime and deep-subprime categories as well. In the past year, dollar values for new vehicle loans to nonprime customers were up 4.1%, from $25,793 to $26,850; for subprime customers, they increased 6.4%, from $23,981 to $25,527 and for deep-subprime customers they went up 9.12%, from $21,866 to $23,862. So in addition to more loans to riskier customers, lenders are freeing more dollars for each loan.
However, this doesn’t need to set off warning bells in the industry. As the lending industry has shown in the past, it will expand and contract its share of subprime loans based on the overall performance of consumers in repaying their loans. Ultimately, this puts the odds in lenders’ favor and keeps automotive retailers — at least for now — with a larger pool of potential customers.
So if you see some of your friends in the automotive lending industry playing a few hands of blackjack during the convention this year, don’t be alarmed. They are just having fun.