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Subprime Lending Idea Proposal

Subprime Lending Idea Proposal
 

Has tighter underwriting isolated the subprime lending problems to 2015 vintages? Are 2017 risk-adjusted returns looking attractive?

Report Available:July 20, 2017

 

Blueshift’s initial research shows the subprime lending industry and auto dealers signaling the end of the subprime lending bubble. Recent loan default metrics have declined for mortgages and auto loans. In addition, the larger banks have pulled back from the subprime market and tightened their lending requirements to limit their risk. These changes have impacted the auto and lending markets. As credit has tightened, demand for new cars has slowed. And used car values have dropped, further curtailing new car demand. At this point, it is unclear whether these current market conditions create an opportunity for subprime lenders to gain share and reignite the auto/credit markets or if the risk of defaults is too high.

 

Observations

  1. On June 20,David M. Blitzer, managing director and chairman of the Index Committee at S&P Dow Jones Indices said, “At the beginning of the year there were reports of a sub-prime crisis in auto loans; these concerns seem to be behind us.”  For the past four months the auto loan default rate has been declining and is now at 0.85% which ties a 10-year low.
  2. This positive turn in the subprime default rate has been achieved in part by tougher lending standards, but that will not protect auto-industry bonds created during the stretch of loose lending from poor performance. A Fitch industry report showed that the 2015 vintage subprime loans are subject to high default and loss rates and are on target to become the worst performing in the history of car-loan securitizations. Smaller lenders heavily dependent on ABS funds could find themselves facing financial challenges if these securities continue to underperform. The Fitch report goes on to indicate that the riskiest period of auto-lending is most likely over as the percentage of subprime and deep-subprime loans is declining, having dropped from 26.48% in Q1 2016 to 24.10% in Q1 2017, representing a 10-year record low for a first quarter.
  3. The freewheeling subprime lending behavior of the past is now negatively impacting both the auto and credit industries. After driving auto sales with subprime loans and accounting for a high of 25.4% of all auto loans, the high default rate has led to a reduction in subprime loans to under 20%. As a result, new auto sales have declined from a peak of 18.7 million units in December of 2017 to a seasonally-adjusted 17 million units in May. Many auto dealers also participated in some of the subprime lending and, as borrowers default and cars are repossessed, they face increasing losses.
  4. On the subprime mortgage front, now being called “nonprime loans”, lenders believe there is an untapped market of borrowers with good credit scores, like self-employed workers who don’t have proper income documentation, or for responsibly-made loans to borrowers with credit problems. These loans are typically originated by brokers and funded by non-bank lenders. A com article said lenders think this market segment has a $200 billion annual potential. The total amount of these types of loans in all of 2016 was $22 billion compared to $1.1 trillion in 2005.
  5. Blueshift’s March 22 subprime lending report found that market conditions would continue to deteriorate, but sources were confident that the industry was reacting to the situation and would correct itself. The strong economy, lenders’ and investors’ ability to manage and evaluate their credit risk, the tightening credit environment, and the industry’s cyclical nature were expected to correct and strengthen the subprime loan market in the next 12 to 18 months, provided that no economic or international crises occurred. Three sources also said subprime auto lenders face declining used car values, which result in losses when a car is repossessed. These challenges are expected to result in industry consolidation, with smaller, poor-performing lenders being acquired and a less-than-stellar 2017 financial performance for subprime lenders. Small subprime lenders, including CACC, are expected to be challenged as the market corrects itself.

 

Are subprime auto loans losses largely contained to the 2015 vintage loans? Which other lending periods are considered high risk? What is the effect of the corrections the finance and banking community has implemented? What is this doing to the risk of a subprime bubble? Is the current subprime lending risk level attractive enough to provide growth opportunities for some lenders?  What are any change in trends regarding negative equity and impacts on the ability to get people into new loans? Which lenders were (or still are) the most aggressive into subprime and how has that changed, if at all? To gain insight into the subprime auto loan market, Blueshift will gather data and issue a market research report from independent sources in the following areas: Used car dealership executives, Auto finance companies, Auto repossession companies, Nonprime mortgage lenders and brokers, and Industry specialists.

  

Companies: Ally Financial (ALLY), AutoNation (AN), Capital One Financial (COF), CarMax (KMX), Credit Acceptance Corp (CACC), Group 1 Automotive (GPI), JPMorgan Chase (JPM), Lithia Motors (LAD), Nationstar Mortgage Holdings (NSM), Penske Automotive Group (PAG), Santander Consumer USA Holdings (SC), Sonic Automotive (SAH), Wells Fargo (WFC)

 

Research Begins: July 3, 2017