Does Crash Near in Subprime Auto Loans Market?
In the summer of 2014 we wrote two columns for The Clyde Fitch Report citing Wall Street’s wolves returning to the subprime loan market — a major culprit in the 2007-8 global meltdown. The first column dealt with subprime loans for small businesses. The second with subprime lending for automobiles and credit cards.
We warned that the markets were smaller than the 2008 housing and derivatives markets that caused the meltdown, but that a smaller bubble in a struggling economy, like today’s, could be devastating if it bursts, particularly considering how public and private debt are the highest they’ve been in history.
Now comes The Wall Street Journal‘s Sunday, March 13 article headlined “Subprime Flashback: Early Defaults Are a Warning Sign for Auto Sales”. The crux of the article: Wall Street is building bonds out of subprime auto loans and selling them to investors. But more and more of the subprime auto loans, as expected, are being defaulted by poor-credit borrowers who eventually can’t pay them back.
Loan payments have been slipping as well for the broader group of subprime borrowers who make up a big slice of the auto market. The 60-plus day delinquency rate among subprime car loans that have been packaged into bonds over the past five years climbed to 5.16% in February, according to Fitch Ratings, the highest level in nearly two decades.
‘What’s driving record auto sales is not the economy, but record auto lending,’ said Ben Weinger, who runs hedge fund 3-Sigma Value LP in New York and who has bearish bets on some auto lenders.
The total volume of U.S. auto loans is now at an all-time high of close to $1 trillion, with a fifth made to subprime borrowers, according to Equifax. Many of those loans are repackaged into bonds to free up capital so that new loans can be made.
Issuance of bonds backed by U.S. subprime auto loans topped $27 billion last year, the highest in a decade and up 25% from 2014, according to Asset-Backed Alert, an industry newsletter that has flagged concerns around Skopos and other ‘deep subprime’ lenders.
This is what we warned about in 2014. Don’t expect this to improve. We saw in January that the subprime auto loan bug had even spread to credit unions. As Credit Union Times wrote in its January 31 article “Credit Unions Warm Up to Subprime Auto Loans”:
According to CO-OP Member Center, a subsidiary of CO-OP Financial Services, more and more credit unions have begun offering subprime auto loans at higher rates to buyers with credit issues...
…One way credit unions are protecting themselves as they make subprime loans is by increasing their rates. ‘They may increase their rates from 8% or 9% to 12% or 13%’…
…Many credit unions are also availing themselves of a new insurance product, called lenders protection, which provides credit unions with protection against losses associated with these types of higher-risk loans.
This “new insurance product, called lenders protection,” is a derivative, because it derives (as do the bonds mentioned earlier) from the original asset: the car. Such products make up the now over $600 trillion derivatives industry, a primary culprit in 2008’s economic crash.
WSJ read Equifax as saying the auto loan market is near $1 trillion. We read its graph below at showing the market at just over $500 billion at the end of 2015, with subprime auto loans representing about one-fifth. As more and more defaults occur, can that bring the market down? It’s disturbing enough to The Wall Street Journal, and to us. Pay close attention to your candidates for President and Congress, and see if it concerns them, and what they plan to do about it.