More people buying cars is a good thing. In a new Industry Report dated October 6th, equity research firm Sterne Agee argues that the recent growth in subprime loans in the auto industry is not a problem given the strength in industry credit trends and asset quality. Analysts Terry McEvoy, Erik Zwick and Austin Nicholas say they would recommend purchasing several of the major regional banks if their shares are impacted by this not-so “bad news” about growth in subprime loans.
The SA analysts explain their perspective: “We would be a buyer of select bank stocks on any short-term underperformance centered on auto lending exposure, especially Fifth Third Bancorp (NASDAQ:FITB), SunTrust Banks, Inc. (NYSE:STI), and TCF Financial Corporation (NYSE:TCB).”
Auto lending volume up
David Einhorn's Greenlight Capital was down 0.1% for the first quarter, underperforming the S&P 500's 6.2% return. In their letter to investors, which was reviewed by ValueWalk, the Greenlight team said a lot happened during the first quarter even though they made just a handful of changes to the portfolio and essentially broke even. Q1 Read More
The Sterne Agee report notes that industry-wide auto loan origination topped $101B in the second quarter of 2014, the highest total since the second quarter of 2006. Moreover, auto lending in the banking industry grew nearly twice as fast as total loans on a year to year basis since they began being included in FDIC data, and were up 10.2% in the second quarter of 2014 compared to 4.9% for all loans.
Industry credit trends still improving
Also of note, while subprime auto lending is up, and now represents more than 22% of total origination compared to around 18% four years ago, subprime remains well below pre-crises levels of close to 30%. Of equal importance, asset quality remains solid as auto loans 90 days or more delinquent have are down from a peak of 5.3% in 2010 to just 3.3% today. McEvoy et al. also note: “Looking just at bank-held auto loans, which are ~60% super-prime, non-current auto loans declined in 2Q14 and stand at ~25bps today.”
Consumers have the spending power
The analysts also highlight that despite being up for the last three years, auto spending is still well below historical levels. Auto loans only represent around 30% of total non-housing consumer debt last quarter, well below the 35% seen throughout the mid 2000s. Furthermore, current U.S. auto spending represents around 3% of total disposable income, significantly less than the long-term average of 4% and the 5-6% average throughout the late 1990s to mid 2000s.