Consumer Auto Credit Conditions Difficult and Will Get Worse for Subprime

The automotive market has been incredibly resilient during this pandemic, but credit is likely to become more challenging in the months ahead, especially as Congress has failed to pass a much-needed additional stimulus package.

The Coronavirus Aid, Relief, and Economic Security (CARES) Act pumped trillions of dollars into the economy and provided support for severely impacted businesses and workers. However, much of the CARES Act support has ended, and the latest auto loan performance statistics reflect deteriorating conditions.

The severe delinquency rate of auto loans normally rises rapidly in a recession, as increasing unemployment saps income and causes consumers to fall behind on payments. The rise in delinquency then leads to more defaults and repossessions. This year has been far from normal, though.

The CARES Act managed to temporarily reduce the impact of the country’s massive 22 million in job losses, which bought the economy time to see almost 11 million jobs brought back. However, we still have almost 11 million on traditional unemployment benefits, and we have more than twice that on some form of support because of lost jobs or income. Worse still, each week more than 800,000 file for benefits as job losses continue. With waning fiscal support, we are on track to end 2020 with more unemployed than we saw across the entire duration of the Great Recession.

Auto loan performance data are now starting to reflect the diminishing fiscal support. The severe delinquency rate declined each month of the pandemic until September. In September, 60+ day auto delinquencies rose by 4.3%, according to a Cox Automotive review of Equifax data. That led to a higher severe delinquency rate, but the rate is still lower than it was pre-pandemic or last year. Without more support, this is just the beginning of the increase.

With even more unemployed and no immediate prospects to see the economy get back to normal, we are likely to see delinquencies rise to match what we saw happen in the Great Recession. If so, severe delinquencies will likely grow by half in early 2021. Defaults and repossessions will follow.

Lenders are expecting this deterioration. Credit in auto, like in the mortgage market, has tightened substantially this year. The most notable signs of tightening are declining loans to subprime borrowers in the new-vehicle market. The decline represents higher credit score standards but also widening spreads that mean that subprime borrowers are seeing auto loan rates that are higher than a year ago. The combination of record-high prices with higher rates and less of an ability to stretch terms means much higher payments. It is an incredibly difficult time to buy if you have poor credit.

Why this matters to the automotive market is that subprime represents close to 20% of all consumers. Unlike housing, vehicle ownership is more egalitarian. However, when credit conditions tighten, consumers with poorer credit have fewer alternatives.

Some brands over-index for subprime consumers and are likely to see sales challenges if we continue to see wider spreads and more difficult terms for subprime borrowers. For example, Mitsubishi’s share of subprime is more than twice the industry average. Dodge and Kia are also more dependent on sales to subprime borrowers.

According to Dealertrack data, lending to subprime is up year to date in the used vehicle market. That means credit is still available, but it only works with a much lower-priced vehicle. This is one of the key factors that has made the used car market so strong in this recovery. Even with growth, the subprime share of used financing has decreased in 2020 because the number of loans to borrowers with higher tier credit has grown faster. Lower credit consumers are not the only ones seeking value in the used car market.

Thus far in October, we are seeing rates move higher for all but the best credit tier, which is an indication that lenders are widening spreads even further. With loan performance now deteriorating and bond yields modestly rising too, credit is likely to become more challenging in the months ahead. A new stimulus package could provide much-needed support, but the timing of that support will likely come after we see surging delinquencies and defaults.