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Proliferation of longer-term auto loans has implications for lenders, investors

Two recentreports highlighted observations about the potential risks associated with longer-termauto loans, a product that has grown in popularity in recent years as consumersseek ways to make monthly payments more affordable.

, in a of new auto loans originated from 2010through the third quarter of 2015, found that the average term to maturity had increasedduring that time frame to 67 months from 62 months and that the amount of loanswith terms of more than 60 months had increased to about 70% of production from50%. The amount of loans with terms of between 73 and 84 months constituted about25% of originations in the third quarter of 2015, up from only 10% in the same periodfive years earlier.

The TransUnionreport found that the duration of auto loans — or the length of time a customerkeeps a loan — had declined, despite the increase in the length of their originalterms. The average spread between original term and duration increased nearly onemonth for loans produced in 2012 relative to those issued two years earlier.

As aresult, TransUnion cautioned, "lenders may not be capturing the benefits ofmore payments and greater interest income they might expect from longer-term loans."

Losstrends observed by TransUnion also suggest that the longer terms have performedmore poorly than shorter-term loans.

The 60-plus-daydelinquency rate associated with loans with original terms of between 73 to 84 monthstotaled 30.7% among subprime borrowers, well above rates of less than 23% apiecefor loans with original terms of between 49 and 60 months and 61 and 72 months,according to the report. The divergence in performance is similar, albeit at muchlower delinquency rates, among prime and super-prime customers.

Beyondthe relative amount of delinquencies, S&P Global Ratings found that changesin loss patterns have emerged as the amount of longer-term loans in subprime autoABS pools increased over time.

S&PGlobal Ratings Senior Director Amy Martin said during a July 13 webinar on ABS markettrends that longer-term loans in those pools had been leading to more back-loadedlosses. The rating agency witnessed a relatively slow increase in the weighted-averageoriginal terms of the subprime retail auto loans tracked by its subprime index toapproximately 68 months for the 2015 vintage from 67 months in 2011 and 64 monthsin 2003, according to underlying research published in May.

S&PGlobal Ratings and Market Intelligence are owned by S&P Global Inc.

Martin'spresentation indicated that the percentage of loans in subprime pools that haveterms longer than 60 months has generally remained at or about 80% for the lastseveral vintages, including 82.4% year-to-date in 2016. Loans with original termsof 72 months have emerged as the most common type offered, and the rating agencyobserved the introduction of products with terms of up to 78 months in the subprimesector beginning in 2013.

"Overall,loans with longer terms amortize more slowly, which we believe, all things beingequal, increases loss severity," the rating agency said in its May report."When amortization of the loan balance is spread out over a longer term, thepoint at which the obligor gains an equity position in the car is delayed."As a result, the size of the outstanding balance would typically be higher at thetime of repossession or charge-off than it would be with a shorter-term product.

S&PGlobal Ratings also hypothesized that longer-term loans could increase the frequencyof default as well, as the magnitude of a borrower's negative equity position andthe length of time the borrower remains underwater could reduce his or her incentiveto meet the obligation.

The ratingagency examined transactions from a handful of issuers that sponsored subprime autoABS in both 2003 and 2011: ConsumerPortfolio Services Inc., FirstInvestors Financial Services Group, Prestige Financial Services Inc.and the AmeriCredit business of what is now GeneralMotors Financial Co. Inc. The loss curve for their 2011-vintage deals,which had more than double the level of loans with terms of greater than 60 months,was both slower and longer than that associated with the 2003-vintage pools.

S&PGlobal Ratings anticipates some weakness in the performance of subprime auto collateral,Martin said, but she expects ratings performance to generally remain "stableto strong," particularly for investment-grade note classes.

The ratingagency said in the report that it continues to monitor the amount and performanceof longer-term loans in subprime auto ABS pools and expects further alteration ofthe loss curves for post-2011-vintage deals as a result of the introduction of loanswith terms greater than 72 months.