Wednesday, Feb. 14, 2007, 07:00 PM UPDATED 11:59 AMBy Nick Zulovich
ATLANTA — Manheim Consulting recently released its Used Car Market Report, which summarized market conditions last year. Reflecting the growing importance of the subprime sector in the overall used-car industry, Manheim devoted quite of bit of discussion to this arena in its report.
Starting with the statistics, the report found that more than $400 billion new- and used-vehicle loans were originated in 2006.
Citing data from Standard & Poor's, Manheim broke the average auto borrow information down by segment:
— Zero to 7 percent of auto borrowers fall into the A category, which includes few delinquencies and an average credit score of 680 or better.
—7 to 13 percent of auto borrowers fall into the B category, showing occasional delinquencies and minor charge-offs on revolving credit. The average credit score in this category is 620 to 679.
—13 to 18 percent of auto borrowers in the nation fall into C category, having poor, limited or no credit history. This pool shows frequent delinquencies, charge-offs on revolving and installment debt and also includes consumers with bankruptcy history. The average credit score in the C range is 550 to 619.
—Finally, more than 18 percent of the population falls into the D category, showing very poor or no credit history. This pool has significant charge-offs, consumers with bankruptcy history and limited income. This category includes auto borrowers with a credit rating of less than 550.
In 2006, Manheim discovered that 44 percent of auto borrowers had loan terms greater than 60 months, up from 12 percent in 2002.
Looking specifically at the subprime category, Manheim Consulting found that auto borrowers with loan terms above 60 months grew to 69 percent in 2006 from 33 percent in 2002.
"The implications of longer-term loans are generally not positive for lenders and remarketers," according to Manheim officials. "Longer loans mean a slower repayment of principal and, thus, a greater severity of loss on repossessions.
"Additionally, the longer its takes to reach positive equity, the more likely borrowers are to simply walk away from the loan. Even absent a repossession, longer-term loans mean a greater frequency and magnitude of negative equity, and this, in turn, can slow future sales, reduce future down payments or lower overall credit standard," executives continued.
"Despite the negative implications, lengthening loan maturities has been an ongoing trend for decades," officials noted. "It keeps monthly payments affordable, offers consumers more flexibility in their personal finances, and allows loans to be based on collateral (the vehicle) that has a much longer useful life. Thus, if done correctly, longer-term loans can provide a beneficial option to both lenders and borrowers."
Discussing interest rates, Manheim pointed out that lower deficiencies and higher recovery rates in the subprime sector allowed lenders to avoid substantially raising rates, or curtailing credit availability in 2006. In fact, the report found that several of the subprime lenders received credit upgrades during 2006, helping to keep increases in cost of capital in check.
Referring to the recent expansion of business by some lenders and acquisitions, Manheim characterized growth in the lending industry as "aggressive, yet rational."
"There is always a temptation in the lending industry to chase unprofitable loans for the sake of growth, but so far, lenders have avoided that in the current cycle. Instead, lenders are growing their businesses by going into markets that they did not previously serve. For example, subprime lenders that in the past primarily dealt with franchised dealers have begun to establish more relationships with independent dealers," the report stated.
"Firms that in the past have focused on only one credit tier have expanded either up or down the credit scale," the report continued. "Firms that used to do only indirect lending, have moved into direct lending. These moves have been accomplished either through internal growth or acquisition."
Commenting on repossessions, Tom Webb, Manheim's chief economist, who headed up the report, said repos increased by 5 percent to 1.4 million units in 2006.
"The increase was driven by higher repossession volumes for subprime lenders and was more a result of a larger number of loans outstanding than higher defaults," he explained.
"Repossessed vehicles sold at auction include a broad mix of models, mileage and conditions because they come from an array of lenders financing a variety of products and customers," he continued. "Accordingly, overall price trends can sometimes be misleading because of major shifts in the types and quality of vehicles sold.
"However, a summary look that segments-out the average price and mileage for subprime repossessions sold at auctions gives a general sense of the pricing strength in 2006. It also shows that after rising sharply in 2003 and staying relatively higher in 2004 and 2005, the average mileage of subprime repos sold at auction in 2006 has declined," he added. "This is due both to lower average mileage on the vehicles at contract inception, as well as a slight uptick in the share of repossessions coming from newer loans."
Overall, the report found that credit conditions supported nonprime and subprime used-vehicle buyers in 2006. However, the publication said this sector had higher rates than in 2005.
"Over the last decade, delinquencies and defaults on these vehicle loans have declined, so mainstream financial institutions have become more confident in lending to nonprime borrowers," official said.
As for buy-here, pay-here dealers, the report pointed out that they dealt with challenging conditions last year.
"The customers to whom BHPH dealers catered a decade ago now often qualify for more conventional loans," Webb said. "Thus, the general credit level of BHPH customers has deteriorated, resulting in a challenging business.
"In addition, BHPH customers faced financial pressures due to higher prices for a number of essentials, particularly energy costs of all kinds," he explained in the book. "Collections are the most important component of a successful BHPH dealership, so as a customer's ability to pay weakens, it often foreshadows future problems."
Editor's Note: For more of Manheim's details on the subprime market, stay tuned to SubPrime Auto Finance News.