Cost of Auto Credit Escalating
There are some incredible things going on at the bottom of the credit pyramid.
In the last few years, many analysts have commented on how the credit scores of American households have deteriorated. For a period of time, FICO revealed that the average credit score was about 690 and that the median is a bit higher. FICO’s data is better than any empirical score because there is inherent bias in the population of people making applications for loans. A few years ago, a broader cross-section of America was applying to buy a home. Today, the picture is different. Plenty of people can read the writing on the wall. It is likely many people with lower credit scores are not even bothering to apply for a mortgage. As a result, today’s average credit score on a mortgage application is probably a poor proxy for average credit. The mortgage applicant’s scores are certainly much higher.
If people can suddenly withdraw from home buying, then fewer can do the same when it comes to buying a car. At some point in time, even the most patient person is going to have to give up on their old vehicle. I have a friend that had nursed a 1997 station wagon through 253,000 miles. She tried to ignore the warning signs for some time – the car was leaking oil and the check engine light was coming on. Soon, it was going to need new tires and there was a timing belt on the horizon. She ran into a problem when it was time to get another car. The used car market is drastically short of supply. To me, that is the telling evidence that people are holding on to their cars, but it also means that new demand will soon be boiling over.
Knowing that everyone needs a new car sooner or later, I decided that car loans would be one of better available proxies for seeing how credit scores have changed over time. There are some companies that specialize in offering credit to the bottom of the pyramid – the buy here pay here industry. The 500-pound gorilla in that field is Credit Acceptance (ticker:CACC), a company that acts as the secondary market for subprime car loans. CACC provides credit to dealers who then turn around and use that money so they can “finance anyone!”
CACC does not offer specific credit score data. However, they do reveal the yield on their loans. Ultimately, that is almost as good as the raw scoring, because it reveals the playing field for the bottom of the pyramid.
What I found was shocking. In 2002, the yield on CACC’s loan portfolio was 12.5 percent. It was virtually the same the next year – just 12.6 percent.
In 2010, the average yield on their portfolio was 34.4 percent. The yield number is a product of three factors. The first is the stated interest rate. The second is the expense for finance charges. Their 10-k suggests that finance charges are much higher than in the past. The third reflects the discount that they get when dealers bring the loans back to CACC.
If you consider how the cost of a mortgage is shrinking, then the rapid rise in the cost of a subprime car loan stands out even more.
Interesting
February 15, 2012
Interesting! I would point out though, that higher finance charges generally indicate higher default rates. The purpose of finance charges, as opposed to interest charges, is generally to offset losses when a debt becomes uncollectable. So if a finance charge is 3% of the loan amount, then you can estimate that roughly the same percentage of loans default and become uncollectable. Its a fairly normal banking practice. This yeilds big returns when the default rate beings improving too.. which is also interesting given the profit increase, that would indicate that the more debtors are making their payment than at the last time the finance charge was adjusted. As a rule of thumb, in my experience, the interest is the profit margin, and the finance charge is to offset typical loss to that class of loans.
Cheers another good article!
Interesting
February 15, 2012
In summary, this article would indicate that things got pretty bad for awhile, so they jacked their fees up. But things are improving, and the default rate has lowered, yielding high fees. Now will they lower their rates back down?? Not if demand for cars explodes.
ZimpleMoney
February 16, 2012
The yield also reflects loans purchased at a discount. As sub-prime borrows use independent car dealers for buying cars, the independent dealer makes the loan and discounts the note and collateral to buyer like CACC. Yields are a result of interest rate and discounts. The overall cost of capital may be lower but the bad debt and charge offs continue to drive costs up and up!
adam r
February 22, 2012
I see that NICK acquired its contracts at a discount of 8.78 percent in 2011.