The Economy

Auto Sales Slowdown Driving Risk for Lenders

Moody's says credit risk is rising at a time when the average dollar amount of negative equity at trade-in is at record levels.
Matthew HellerMarch 28, 2017
Auto Sales Slowdown Driving Risk for Lenders

Amid a slowdown in car sales, auto lenders are facing “significant” credit risk as they compete for a shrinking supply of loans by loosening loan terms and rolling negative equity from prior loan balances into new loans, according to Moody’s Investors Service.

In a new report, Moody’s said it expects U.S. new vehicle sales to decline slightly to 17.4 million units in 2017 after hitting a record annual high of 17.55 million units last year.

“Now that new vehicle-sales have plateaued, the competition for remaining loan supply will intensify, driving increased credit risk for auto lenders,” said Jason Grohotolski, a senior credit officer at Moody’s.

That need for auto lenders to be more accommodative is, in turn, compounding credit risk on auto lenders’ balance sheets at a time when the average dollar amount of negative equity at trade-in is at record levels, Moody’s said.

In the first nine months of 2016, around 32% of U.S. vehicle trade-ins carried outstanding loans larger than the worth of the cars, a record high, according to auto website Edmunds.

According to Moody’s, the accumulation of negative equity over the course of multiple trade-ins — which it calls the “trade-in treadmill” — results in “increasing lender risk, with larger and larger loss-severity exposure.”

Lenders have also accommodated borrowers by extending original loan terms — average terms continue to extend into the 72- to 84-month category — slowing principal amortization for the sector at large.

“With every successive year, lenders’ profitability is getting thinner and thinner, and their credit losses have been growing,” Grohotolski told Reuters.

In another recent report, Fitch Ratings predicted auto loan and lease credit performance will continue to deteriorate in 2017, led by the vulnerable subprime sector. “Subprime credit losses are accelerating faster than the prime segment, and this trend is likely to continue as a result of looser underwriting standards by lenders in recent years,” said Michael Taiano, a director at Fitch.