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What’s Happening with Subprime Auto Loans?

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Auto loans have shot past the $1 trillion mark in the United States and now make up a significant component of the overall consumer debt picture.

Subprime auto loans – which are riskier loans made to customers with poor credit – have helped to drive the market since the Great Recession. However, with auto loan delinquencies ticking up in recent months, investors have been searching for answers about the sector.

Are we in for some sort of subprime auto loan crisis, or is there another explanation for what is going on?

Subprime Auto Loans: a Shifting Market

The data and perspective in today’s infographic comes from consumer credit reporting agency Equifax, and it helps to explain what is potentially going on in today’s auto loans market.

What's Happening with Subprime Auto Loans?

Does the recent uptick in auto loan delinquencies represent the unhinging of the market, or is it just standard fare?

Auto Loan Segmentation

The auto loan market is surprisingly diverse, and it’s comprised of many different types of lenders.

Each lender has a unique set of criteria for their ideal customer. For example, banks want very little risk and typically only lend to customers with prime credit scores (620 or higher). Dealer finance companies, on the other hand, are willing to take on more risk in their portfolios, and usually key in on subprime customers.

In fact, there are six different types of lenders in the auto lending space:

  1. Banks: Depository institutions that loan money to third-parties
  2. Credit Unions: Member-owned financial cooperatives
  3. Captive Auto Finance: Financing arm of an auto brand (i.e. Ford Motor Credit Company, etc.)
  4. Dealer Finance Companies: Associated with a dealerships or dealer chains
  5. Monoline Finance Companies: Focus on auto loans through multiple dealers/platforms
  6. Independent Finance Companies: Offer auto loans and other loan types

Because they each approach the market differently, there is strong segmentation in the market. The following chart from Equifax shows a snapshot of loans made in Q1 of 2015 and their cumulative non-performance after 18 months on the books:

Non-performance of auto loans vs. credit score

However, let’s look at this again by plotting the median credit score for new loans originated in Q1 of 2006, 2009, 2012, and 2015.

Non-performance of auto loans vs. credit score, longer time series

After the financial crisis, banks tightened credit standards until performance improved. Monoline and dealer finance companies, on the other hand, continued to lend to high-risk borrowers – and it is these companies that are seeing non-performance rates shifting higher.

In other words, it is the market share and relative performance among lenders that are the change drivers for aggregate loan statistics.

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Markets

Beyond Big Names: The Case for Small- and Mid-Cap Stocks

Small- and mid-cap stocks have historically outperformed large caps. What are the opportunities and risks to consider?

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A line chart showing the historical return performance of small-, mid-, and large-cap stocks.

 

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The following content is sponsored by New York Life Investments
An infographic comparing low-, mid-, and large-cap stocks, including an area graph showing historical returns, a bubble chart showing how much $100 would be worth over 35 years, a horizontal bar graph showing annualized volatility, and a line graph showing relative forward price-to-earnings ratios, that together show that mid-cap stocks present a compelling investment opportunity.

Beyond Big Names: The Case for Small- and Mid-Cap Stocks

Over the last 35 years, small- and mid-cap stocks have outperformed large caps, making them an attractive choice for investors.

According to data from Yahoo Finance, from February 1989 to February 2024, large-cap stocks returned +1,664% versus +2,062% for small caps and +3,176% for mid caps.  

This graphic, sponsored by New York Life Investments, explores their return potential along with the risks to consider.

Higher Historical Returns

If you made a $100 investment in baskets of small-, mid-, and large-cap stocks in February 1989, what would each grouping be worth today?

Small CapsMid CapsLarge Caps
Starting value (February 1989)$100$100$100
Ending value (February 2024)$2,162$3,276$1,764

Source: Yahoo Finance (2024). Small caps, mid caps, and large caps are represented by the S&P 600, S&P 400, and S&P 500 respectively.

Mid caps delivered the strongest performance since 1989, generating 86% more than large caps.

This superior historical track record is likely the result of the unique position mid-cap companies find themselves in. Mid-cap firms have generally successfully navigated early stage growth and are typically well-funded relative to small caps. And yet they are more dynamic and nimble than large-cap companies, allowing them to respond quicker to the market cycle.

Small caps also outperformed over this timeframe. They earned 23% more than large caps. 

Higher Volatility

However, higher historical returns of small- and mid-cap stocks came with increased risk. They both endured greater volatility than large caps. 

Small CapsMid CapsLarge Caps
Total Volatility18.9%17.4%14.8%

Source: Yahoo Finance (2024). Small caps, mid caps, and large caps are represented by the S&P 600, S&P 400, and S&P 500 respectively.

Small-cap companies are typically earlier in their life cycle and tend to have thinner financial cushions to withstand periods of loss relative to large caps. As a result, they are usually the most volatile group followed by mid caps. Large-cap companies, as more mature and established players, exhibit the most stability in their stock prices.

Investing in small caps and mid caps requires a higher risk tolerance to withstand their price swings. For investors with longer time horizons who are capable of enduring higher risk, current market pricing strengthens the case for stocks of smaller companies.

Attractive Valuations

Large-cap stocks have historically high valuations, with their forward price-to-earnings ratio (P/E ratio) trading above their 10-year average, according to analysis conducted by FactSet.

Conversely, the forward P/E ratios of small- and mid-cap stocks seem to be presenting a compelling entry point. 

Small Caps/Large CapsMid Caps/Large Caps
Relative Forward P/E Ratios0.710.75
Discount29%25%

Source: Yardeni Research (2024). Small caps, mid caps, and large caps are represented by the S&P 600, S&P 400, and S&P 500 respectively.

Looking at both groups’ relative forward P/E ratios (small-cap P/E ratio divided by large-cap P/E ratio, and mid-cap P/E ratio divided by large-cap P/E ratio), small and mid caps are trading at their steepest discounts versus large caps since the early 2000s.

Discovering Small- and Mid-Cap Stocks

Growth-oriented investors looking to add equity exposure could consider incorporating small and mid caps into their portfolios.

With superior historical returns and relatively attractive valuations, small- and mid-cap stocks present a compelling opportunity for investors capable of tolerating greater volatility.

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