Auto Loans Reach Trillion-Dollar Heights, but Is Deceleration in Sight?

At a time when scrutiny of subprime auto loans is high, Cleveland Fed examiners see signs that banks in the Fourth District may be beginning to rein in their auto lending.

Auto lending by banking institutions, automobile financing companies, and auto dealers has climbed since 2011—and with it, so has subprime auto lending—but Cleveland Fed bank examiners say that bank holding companies, or BHCs, in this region have not grown their subprime auto lending portfolios as much as others, particularly nonbanks.

It’s been the case for years that at least 1 in 5 auto loans originated is subprime, defined here as loans to borrowers with credit scores lower than 620. Specifically, the percentage of total auto originations that is subprime has exceeded 20 percent since the third quarter of 2011, according to data from the Federal Reserve Bank of New York Consumer Credit Panel, Equifax, and Haver Analytics.

Michael R. Metalonis
Michael R. Metalonis

Still, it’s not 30 percent, the percentage at which subprime originations hovered during the quarters preceding the Great Recession. And subprime originations are focused with specific lenders. Federal Reserve Bank of Cleveland examiner Michael R. Metalonis notes that “there are a few banks and bank holding companies that participate heavily in the subprime space—none of which is based in the Fourth District. A lot of the subprime originations are occurring outside of banks and actually are occurring in auto finance companies.”

“Most banks don’t originate a lot of subprime auto loans because of the intense competition, and they cannot achieve the appropriate risk-adjusted return,” he adds. “Furthermore, for most banks, originating a lot of subprime auto loans is outside their risk appetite.”

Generally, pertaining to auto lending, Metalonis says, “We are seeing increasing risk because of layering in risk: a combination of lower FICO scores, longer terms, higher advance rates. The combination of these tends to lead to higher default rates and higher losses over time.”

Jenni M. Frazer
Jenni M. Frazer

When it comes to the more than 170 bank holding companies in the Fourth Federal Reserve District, which comprises Ohio, western Pennsylvania, the northern panhandle of West Virginia, and eastern Kentucky, subprime originations have been relatively stable during the past couple of years, says Jenni M. Frazer, a Federal Reserve Bank of Cleveland vice president overseeing the supervision of large banking organizations, or those with more than $50 billion in assets.

“In terms of performance, we’re seeing stable underwriting criteria,” Frazer adds. “We’re not seeing anything now in our District that is overly concerning to us about the quality of originations or large growth in subprime-type loans.”

The vast majority of subprime loans are originated by auto finance companies, according to the Federal Reserve Bank of New York’s Liberty Street Economics blog. In a November 30 post, the authors note, “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 ninety-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.”

The post’s authors conclude that the data they analyzed suggest “some notable deterioration” in subprime auto loans’ performance. Roughly 6 million individuals are at least 90 days late on their auto loan payments, they write, and even though the balances of subprime loans are somewhat smaller on average, the increased distress is likely to have ongoing consequences for affected households.

A trillion dollars—and counting?

Driven by demand for new and used vehicles, total auto loans and leases have climbed for years and for the past 6 quarters have topped $1 trillion—heights not reached in all the years dating from 1999, the earliest year for which data from the Federal Reserve Bank of New York Consumer Credit Panel, Equifax, and Haver Analytics are available.

In addition to the way in which auto manufacturers’ growth has fueled auto lending’s rise, Metalonis notes that such loans generally are desirable for bankers to book. Their terms are shorter compared to other loans, and they can be sold into active secondary markets through securitizations. Securitizations can provide additional liquidity for banks to continue making new loans.

Low interest rates and attractive incentives by manufacturers continue to fuel the growth, too, notes Janice Sung, a senior examiner with the Cleveland Fed.

Year-over-year growth in auto loans for US bank holding companies was 7 percent in the third quarter of 2016, the lowest it’s been since the fourth quarter of 2013, according to data pulled from Consolidated Financial Statements for Holding Companies.

Meanwhile, year-over-year growth in auto loans for bank holding companies in the Cleveland Fed’s region in the third quarter of the same year was 4 percent, roughly what it was in the preceding quarter. Before then, growth hadn’t been 4 percent or higher since the first quarter of 2015.

Federal Reserve Bank of Cleveland examiners see signs that the multiyear acceleration in auto lending will abate in coming years.

“Overall, we’ve been hearing through analysts calls that there does seem to be some growing sentiment from investors of concerns of potential slowing in auto loan growth,” Sung explains. “And there’s evidence of banks’ already reducing some of their exposure and changing some of their limits.”

Generally, the expectation is that volume will decline as interest rates rise, she adds.

Problem loans and concerns

Bank holding companies in the Fourth Federal Reserve District have fared better in at least one metric of auto loan performance—the percentage of delinquent and nonperforming auto loans to total auto loans—when compared to all BHCs in the United States, according to data from Consolidated Financial Statements for Holding Companies.

Whether there is cause for concern from a regulatory standpoint if auto lending by banks continues to rise is a “case-by-case scenario,” Metalonis says.

“It depends on what institution you’re looking at and what its risk appetite is and what its underwriting practices are, how it achieves that growth,” he explains. “There are some banks that only originate auto loans in the prime and super-prime space. There are other banks that operate in the subprime market.”

Discussions regarding risk management, underwriting practices, and the like are not specific to auto loans, Sung says. Bank examiners have ongoing discussions with bankers regarding many different asset classes.

What is unique to consumer products such as auto loans is regulators’ emphasis on the need for bankers’ compliance with laws and regulations related to consumer protection, Frazer says. Several banks face public enforcement actions brought by the Consumer Financial Protection Bureau related to their indirect auto lending.

Indirect lending comprises auto loans originated by dealerships and funded by banking institutions.

“Indirect lending is a concern for the banking industry and the regulatory agencies because of the complexities of how these loans are originated, typically through third parties,” Frazer says. “If you’re going to be in this business, you need to make sure you have the risk management infrastructure to comply with laws and regulations relating to consumer protection.”

Of paramount importance is bankers’ ensuring they’re making loans fairly and transparently through disclosures and that no group is receiving preferential or disparate treatment, she says.

Sum and substance: At a time when riskier auto lending is making headline news, bank holding companies in the Fourth Federal Reserve District have maintained a stable volume of subprime auto loan originations.

Federal Reserve Bank of Cleveland senior examiner, credit analytics, Juan Carlos Calzada contributed to this article.

*This article reports data from the FRBNY Consumer Credit Panel/Equifax/Haver Analytics.