Auto lending is vigorous even as high-risk delinquencies build

Auto loans have grown for 26 straight quarters, drawing more scrutiny of the expansion of the riskiest slice of the market, where delinquency rates are also up, a New York Federal Reserve report out Tuesday showed.

Banks and traditional lenders remain conservative, largely limiting borrowing to higher-rated customers even as the U.S. job picture remains upbeat. But their nonbank competition—including the financial arms of the auto manufacturers themselves GM, -1.31% F, -1.15% TM, -0.64%  or lenders that operate from a “captive” position as part of the dealerships—has a different tack. Looser borrowing in this category risks exposing troubled loans should the economy turn south, Fed commentators said.

Read: Competitive high-risk auto-loan market accepts looser credit: S&P

Almost 9.7% of subprime car loans made by nonbank lenders were more than 90 days past due in the third quarter, the highest rate in more than seven years, according to the New York Fed’s quarterly report. That’s more than double the 4.4% delinquency rate for subprime loans made by traditional banks, a number that’s largely improved since the end of the financial crisis.

In all, there were $1.2 trillion in auto loans outstanding in the U.S., up $23 million from the previous quarter. About 20% of new car loan originations are subprime.

The auto loan figures were included in a broader New York Fed report that revealed household debt overall rose by $116 billion, or 0.9%, to $12.96 trillion in the third quarter.

“The subprime delinquency rates are really where the pressure is,” analysts at the Fed wrote in a blog post accompanying the report, an update to their review of the auto market about a year earlier. “The delinquency rate — even among borrowers in the same credit score bucket — is considerably higher and rising on the auto finance side.”

Where auto loans are sourced increasingly impacts the risk quality. Only about one-third of all outstanding subprime auto debt, that carried by the lowest-rated borrowers, was originated by banks and credit unions. Auto-finance companies scoop up the remaining two-thirds of the business. The latter’s share has almost doubled since 2011, valued at more than $200 billion as many traditional banks relinquish their share, sometimes willingly to cut exposure to riskier auto loans and sometimes because they’re simply being edged out in this competitive space.

Santander Consumer USA Holdings Inc. SC, -0.94%  , which is counted among the biggest subprime auto-loan firms, verified income on just 8% of borrowers on loans it recently bundled into $1 billion of bonds, Moody’s Investors Service said in a May report.

Read: Some senators want to ‘protect’ consumers’ credit — but they’re vague on details

Traditional lenders are being more careful with the credit ratings carried by borrowers. The median credit score among auto borrowers increased to 705, as the higher level of auto loan originations in the third quarter was mainly due to growth in originations to high-rated prime borrowers; origination volume to borrowers with credit scores under 660 declined, the Fed data showed.

When loans just above subprime are factored in, there were more than $435 billion in auto loans to borrowers with credit scores below 660 outstanding (subprime is below 620 and excellent credit is 760 and above) during the third quarter, the report found. That total has been climbing steadily since bottoming out at $249 billion in early 2011.

The Fed commentators, Andrew Haughwout, Donghoon Lee, Joelle Scally and Wilbert van der Klaauw, stressed that the possibility of subprime auto lending contagion spreading through the larger financial sector is remote, considering its small share of overall debt compared to the mortgage market. Underwater mortgages, of course, were one of the key culprits to the economy’s unraveling about a decade ago.

Still, more than 23 million consumers have subprime auto loans and the potential risk to household financial health can’t be ignored. “These consumers may find their credit reports further damaged after a default or encounter further financial difficulties after experiencing a car repossession,” the Fed bloggers said.

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