Car Sales Drive A Return To Subprime

New auto loan originations are at record highs, according to an Equifax (EFX) National Consumer Credit Trends Report released this month, thanks to low interest and unemployment rates.

Severe delinquency rates are the lowest that they have been in nearly 20 years, with outstanding loans more than 60-days past due for April 2025 at 0.81%. The rate was 1.15% in January.

"More consumers are staying current on their payments, which is due to both improved economic conditions and the fact that lenders and dealers are qualifying the right borrowers across the entire credit spectrum," Dennis Carlson, deputy chief economist at Equifax, said in a release.

Auto leasing has grown among both banks and finance companies, according to the report. In April 2015, bank portfolios held 973,100 auto leases and finance companies held 6.63 million leases, equaling 12.1% and 19.1% year-over-year growth rates, respectively, in outstanding lease accounts.

Large consumer loan firms such as Santander Consumer USA (SC), as well as smaller lenders like Credit Acceptance (CACC), are benefiting from people returning to work and needing car loans.

Both concentrate on subprime loans — loans to consumers with FICO scores below 650 (FICO, formerly Fair, Isaac and Co., is a software company with a widely-used credit-rating system). Lower credit scores generally connote higher-risk borrowers, and lax subprime standards are largely blamed for the housing market collapse that led to the 2008 financial crisis. It is maybe a sign of a recovering economy, or possibly a hint of impending danger, that analysts now say subprime loans on automobiles pose less risk.

"There is collateral there because there is a car, so lenders are more comfortable making loans," said Chris Donat, an equity research analyst at Sandler O'Neill & Partners. "Auto loans have performed pretty well coming out of the crisis.

1. Business:

Subprime lenders serve an audience of consumers who don't qualify for traditional loans. To cover the risk of a default, the lender charges a high interest rate for the risky loan. Equifax reported that subprime accounted for 24.2% of the auto lending market in January and February, up from 23.5% a year ago.

Santander Consumer USA is bringing some fresh thinking to the business. It teamed up with ride-hailing service Uber, part of Uber's Vehicle Solutions partnership that helps Uber's drivers finance vehicles in order to get on the road. The loan payments are deducted weekly from the driver's Uber earnings.

Santander is over 60% owned by Santander Holdings USA, a subsidiary of Spain-based Banco Santander (SAN).

It also offers traditional auto loans to prime lenders, including a 10-year deal to originate loans with Chrysler Group, a division of London-based Fiat Chrysler Automobiles (FCAU).

Santander declined to be interviewed for this article.

Smaller firm Credit Acceptance also originates auto loans. Its portfolio program advances money to dealers for the right to service the underlying loan. Its purchase program buys consumer loans from dealers.

Credit Acceptance is thinly traded but has a 97 Composite Rating from IBD. Santander Consumer USA has a rating of 98, with the best possible being 99. IBD's Composite Rating measures stocks in five areas, with extra weight on earnings and stock price strength.

Other companies are jumping on the lending bandwagon. A chain of used car dealerships,CarMax (KMX), started originating its own auto loans in 2013. Total income from the finance unit jumped 15.3% to $109.1 million in the first quarter.

The Finance-Consumer Loan group doesn't just feature auto lenders. World Acceptance (WRLD) offers unsecured consumer loans, operating in 14 states and Mexico. Unlike lenders offering very short-term "payday loans," World Acceptance and its peers — like Regional Management (RM) — issue small, high-interest loans that amortize over 10-36 months.

Earlier this month, Janney Montgomery Scott began coverage on World Acceptance with a buy rating. On June 2, the company announced that chairman and chief executive Alexander "Sandy" McLean would step down on Sept. 30, after 26 years with the company. Chief operating officer Janet Lewis Matricciani was appointed to the CEO role.

In an example of how skittish investors can be toward niche lenders, on Thursday, FBR Capital downgraded World Acceptance to market perform, from outperform, based on valuation. The stock collapsed 20% in huge trade — its second such collapse since March. Other stocks in the group felt no real impact. Pawn-shop chain and payday lender Ezcorp (EZPW) dropped 4% in heavy trade, following news Thursday that the company was being investigated for delaying its fiscal second quarter report, citing accounting reasons.

The Finance-Consumer Loan group on Friday ranked No. 24 out of the 197 industry groups IBD tracks, down from a No. 12 rank four weeks ago.

2. Market:

While the companies may in some cases sound a bit shady, they serve a vast constituency. According to the Federal Deposit Insurance Corp., 7.7% of U.S. households in 2013 had no bank accounts. Another 20% of households were "under-banked," using alternative financial services in combination with traditional banks. Janney analyst John Rowan said in the June 16 initiation note that credit bureaus are changing models in ways that raise the credit scores at the lower end the spectrum, increasing consumer access to credit and banking options.

While that has loan insurers sounding more cautious, Donat says he sees no signals that the market for consumer loans is slowing.

"I hear a fair amount of caution even though the credit quality is good," he said. "Just because management teams sound cautious doesn't mean they are slowing their loan growth.

He said the consumer-loan industry is growing slightly faster than the overall market, with auto loans running at a faster clip.

Lower interest rates have made loans more attractive. Cheaper gasoline has helped put more money in consumers' pockets, making them less likely to default. But Donat said it's too early to see how low oil prices might flow through to consumer credit.

"Because interest rates are so low, there is demand from lenders to fund other people's loans and get some yield," he said.

3. Climate:

Regulations are the biggest wild card facing the consumer loan industry. Earlier this month the Consumer Financial Protection Bureau created new rules on non-bank auto lenders defining auto loans as a consumer financial product or service.

While Donat doesn't think the change will have a major impact on the industry, there is a risk that more regulations will be passed.

He doesn't think smaller firms are doing better than larger institutions, but said there are more regulatory pressures and oversight on larger firms vs. smaller ones, especially in the wake of the financial crisis.

The strengthening job market also helps. Applications for unemployment benefits in the U.S., for the week ended June 6, were below 300,000 for the 14th straight week. More jobs drives up auto demand — more people need cars to get to work and are less likely to be late on payments or default on their loans.

Lower interest rates also have helped reduce barriers of entry into the industry, increasing competition.

"But if we are in a different interest rate environment or if credit economy deteriorates, it might be a tougher environment for lending startups," Donat said.

4. Outlook:

Analysts are bullish on the industry as more Americans return to work and need cars and credit in the aftermath of the financial crisis. But it's a high-risk industry and always faces challenges.

"The biggest risk is that the economy turns, and if people start losing their jobs and they start falling behind on their credit cards, student loans and auto payments," Donat said.