United States

Economic recovery has been a mixed blessing for specialty auto lenders

The good, the bad and the necessary


The gradual economic recovery has been a mixed blessing for specialty lenders, specialty auto lenders in particular. The good news?

  • Most subprime specialty auto lenders make loans at rates of 18 percent or higher. So the fact that the Federal Reserve continues to hold off on interest rate hikes has helped. For lenders borrowing from commercial banks, very low rates mean a very wide spread between their current borrowing costs and the interest rates on the loans they make. A move of a few basis points would have little immediate impact, but should rates rise more significantly, it will eat into margins.
  • For those accessing capital through other channels, a healthy market for loan securitizations and strong interest in the sector among private equity firms mean solid sources of capital. Private equity interest also offers a good market for owners looking for an exit strategy.
  • Used car prices are high, which keeps collateral values up and means good returns on repossessed vehicles.

But not all the news is positive. The bad news?

  • Specialty auto lenders are seeing intense and rising competition. Not only are traditional specialty lenders fighting for borrowers, a new breed of online lenders with lower cost structures have entered the market. Their effect thus far has been marginal, but it is a trend that bears watching.
  • Delinquencies have also increased in the subprime market. While unemployment is down, underemployment continues, contributing to this issue. Also, heightened competition is pushing some lenders to make questionable loans. Another contributing factor? As of Jan.1, 2015, members of the military can no longer opt to have payments on loans secured by personal property automatically deducted from their paychecks through the military allotment system. Some specialty auto lenders do significant business with military personnel, and this change has increased delinquencies and defaults in that market.
  • Specialty lenders are seeing increased regulatory scrutiny. Specialty lenders traditionally have been regulated at the state level, but with the passage of the Dodd-Frank Act and the creation of the Consumer Financial Protection Bureau, specialty lenders now face heightened federal regulatory oversight as well.

What should specialty auto lenders do now?

  • Focus on efficiency. With online lenders entering the market, competition is only going to get more intense. The Fed may not have moved on interest rates yet, but they will eventually. So margins will get at least a little tighter. Now is the time for lenders to make sure they are doing all they can to control their costs.
  • Hold the line on lending standards. Lenders who let tougher competition push them into unwise loans will pay the price with increased delinquencies and defaults.
  • Ensure their regulatory practices are in order. With new regulations on the federal level, lenders need to make sure they understand and are prepared to comply with the rules for compliance. Developing and monitoring a compliance management system is crucial. Adverse attention could not only cost money in penalties, it could also bring considerable negative publicity.

Total auto loan origination by credit score

Subprime auto loans as a percentage of total auto loan origination