What do you get when you add post-election uncertainty to pre-election “economic contradictions?” Many see trouble on the way, but after a period of mixed data and projections concerning interest rates, consumer spending and borrowing, and of course, election results, the months ahead promise to bring some clarity to subprime auto.
Below is a review of recent performance and anticipated events on the road ahead.
Originations
At mid-year 2024, total auto loan balances stood at $1.63 trillion, up $10 billion for the second quarter.
Subprime auto originations continue to decline. For comparison, superprime originations in Q2 2024 were up 10.3% year over year. For borrowers with subprime credit scores, (credit score <620), the percentage of loans issued as of mid-year 2024 was only approximately 13.9% of total account balances, according to Equifax. The decline in subprime originations was 27.4% from Q1 2019 levels, according to TransUnion, citing affordability concerns.
Some subprime auto lenders have relaxed their credit standards. Cox Automotive noted a surprise reversal in its Dealertrack Credit Availability Index for September. The Index showed looser credit across most channels and all lender types following five months of tightening. Subprime’s share of approvals increased by 30 basis points for the month, up by 1.2% year over year.
A trend towards easier subprime credit access bears watching given recent disappointing loan performance.
Delinquencies
Auto loan delinquencies are being driven by subprime and near-prime borrowers, according to a recent study from the Federal Reserve. A finding echoed by S&P Global, which noted delinquencies have been on the rise, reaching “decade highs.”
The subprime delinquency rate is outpacing the overall rate and may be accelerating. In July, subprime auto loan defaults rose by 2.5% from the previous month, and were up 35.9% year over year, according to Cox. In August, subprime, 60+ day delinquencies were up 26 basis points from the previous month, rising 20 basis points year over year to 5.17%, Morgan Stanley and Intex data showed.
Securitizations
So far, the ABS market has seen the warning lights and shrugged. As of Q3 2024, new issuance in auto ABS reached $137 billion, up 17% over the same period last year, according to the Structured Finance Association.
Volumes in subprime auto issuance grew by 9%. Nonprime issuance grew even more strongly, by 31%. Finsight data confirms the trend: 2024 has seen approximately $40.9 billion in subprime ABS issuance across 70 deals, up from 2023's $35.4 billion across 73 deals.
However on a cautionary note, S&P Global expects auto ABS issuance to moderate during Q4 2024 given recent deterioration in the market.
In fact, the boom in subprime ABS could be masking some troubling credit dynamics. S&P Global’s U.S. Auto Loan ABS Tracker reported for August that losses have “spiraled upward, especially for subprime” for the third consecutive month. Subprime losses in August were the highest since 2009.
The 2022 subprime vintage is a particular concern. Of S&P Global’s three ABS ratings downgrades in September, all were subprime transactions from 2022. Cumulative net losses appear to be peaking in the 2022 vintage, while the 2023 vintages have been improving.
The future direction of subprime auto ABS now stands at a crossroads of potential legal, regulatory and economic forces.
Looking Ahead: Subprime Wildcards
The Economy:
A downturn in macroeconomic conditions, such as a recession or a rise in the unemployment rate, historically affects subprime auto loan borrowers especially hard. Inflation, in particular, impacts subprime borrowers earlier and harder than it does those in the prime segment. There is the potential for a “delinquency churning” effect where an increase in monthly auto payments and insurance premiums continues to outpace wages and rising numbers of subprime borrowers remain stuck, (i.e., “churn”) in delinquency status, unable to become current on their obligations.
Litigation Begins:
A lawsuit filed this past spring in a California federal court against underwriter Credit Suisse Securities may signal the advent of investor claims related to subprime auto securitizations. Plaintiffs, including River Canyon and other investment funds, allege securities fraud, and intentional and negligent misrepresentation. Credit Suisse allegedly failed to disclose that “the Sponsor/Seller of the Trust and its affiliates were in serious financial trouble” which would impair “a material portion of the Trust’s collateral.” The sponsor and seller here was U.S. Auto Finance Inc., an affiliate of originator U.S. Auto Sales, Inc. In 2023, these and other U.S. Auto entities filed for bankruptcy and plaintiffs allege Credit Suisse’s earlier access to the company’s books and records “would have revealed its dire financial condition.” The court recently ordered a briefing schedule on the defendant’s motion to dismiss that extends to early 2025.
We noted the distress at U.S. Auto in a previous subprime auto update. Although we have not seen significant bankruptcies in 2024, bankruptcy is not needed for litigation to commence where there is otherwise a sufficient basis to allege misleading representations or lack of disclosure. Claims could extend beyond underwriters to any party in a position to learn of distress or other issues, such as servicers. Given statutes of limitations, past troubles can come home to roost years later.
Regulatory Roulette:
We are closely watching the litigation in Consumer Financial Protection Bureau v. Credit Acceptance Corporation. As we discussed in our previous subprime auto update, through this lawsuit the consumer finance watchdog would bring the ability to repay standard to subprime auto. In the latest developments in the case, CAC's motion to dismiss has been fully briefed. Amici have weighed in with briefs on both sides. We await a decision.
At least prior to the election, the Consumer Finance Protection Bureau (CFPB) appeared poised to wage a wider enforcement campaign in subprime and elsewhere. This past spring, the agency survived a challenge before the U.S. Supreme Court to the constitutionality of its funding structure, in CFPB v. Community Financial Services Ass'n of America.
The latest edition of the CFPB’s Supervisory Highlights report is a “special edition” entirely devoted to auto finance. The report discusses numerous complaints that the agency’s examiners have investigated against lenders, finance companies and servicers. In subprime, auto loan originators (not identified in the report) are alleged to have engaged in such deceptive or abusive acts or practices as providing customers with disclosures that were inadequate, or placing add-on products that the consumer did not authorize.
The CFPB’s June report on Negative Equity in Auto Lending raises yet another direction for regulatory enforcement. The post-pandemic era is one of faster-than-normal vehicle depreciation. Trade-ins and refinancing transactions in such an environment bring heightened risk of delinquencies and defaults. The connection between financing with negative equity and a greater likelihood of repossession is a major theme in the CFPB’s report. While the agency remains only in information gathering mode on the rise of negative equity, the report suggests that servicing practices are more prominently on the Bureau’s radar.
Final Word:
The outcome of the Credit Acceptance litigation and the direction of the CFPB post-election could upend numerous assumptions in subprime auto finance. A clearer road is up ahead - for better or worse.
James Mowder, an attorney in the Bankruptcy, Creditor's Rights + Finance practice group, contributed to this post.
