Auto lenders are making more loans to weaker borrowers as consumer demand for cars increases and low interest rates continue to fatten profit margins, according to a Moody's report released Friday.
The Moody's report, which analyzes third-quarter data compiled by Experian, also found ample evidence for weakening lending standards in the subprime auto loan market.
Banks increased subprime auto loans by 1% in the third quarter, while credit unions saw a 9% gain.
Low interest rates and relatively low losses on subprime auto loans thus far have also emboldened lenders to make riskier loans, according to the report.
"Low rates give even smaller lenders low-cost funding and enable high margins, especially on high-yielding subprime loans," Moody's said in the report. "Losses, though increasing, are still relatively low, which means that lenders have room for performance to weaken before high losses make profit margins unattractive."
Lenders also lengthened the terms of subprime auto loans in the third quarter. The average term for subprime used car loans climbed to 60.9 months in the third quarter, up from 59.9 months during the same period a year ago. The average term for subprime new car loans also increased, climbing to 70.5 months compared to 69.9 months.
Longer loan terms offer customers lower monthly payments, which means that subprime borrowers often make less of a dent in loan principal before defaulting. The trend may "mean higher losses on liquidated vehicles," Moody's said in the report.
The average loan-to-value ratio for subprime loans also increased in the third quarter, indicating that lenders are taking on more risk. Average loan-to-value ratios on subprime loans to new car owners rose to 143% in the third quarter, up from 140% in the third quarter of 2012. Average loan-to-value ratios for used car loans increased to 128%, up from 125%.
Still, the average credit scores for borrowers buying used vehicles stabilized. It was 668 in the third quarter, the same average credit score as a year ago. Moody's analysts pay close attention to credit scores for people who purchase used cars since subprime borrowers typically take out loans for used cars rather than new vehicles.
Another Moody's report released Friday predicts that recoveries on defaulted auto loans in prime and non-prime auto loan asset-backed securities will fall over the next 12 months and stabilize starting in 2015.