Keeping calm about US auto finance concerns

Robert Sierra - 31 May 2017

The expression “sub-prime” still strikes terror in the public mind after the US mortgage debacle a decade ago, as depicted in “The Big Short”.  However, recent reports of a brewing crisis in sub-prime auto loans should not be considered remotely comparable to the events that triggered the global financial crisis. It is true that US auto loan delinquency rates are rising and that allegations of mis-selling abound. Indeed, US government enforcement officials have expressed concern that lenders may be making loans that borrowers can’t repay and packaging them into bonds for gullible investors. However familiar this sounds, the scale of the activity and the inherent risks are significantly smaller.

In recent years, large banks and finance companies have extended loan terms and relaxed underwriting standards to keep up with rampant competition for auto loans and leases. Investment banks have structured such loans into securities to feed to undiscriminating yield-hungry investors. Moreover, consumers have signed up to larger loan amounts on the assumption that, if conditions turned sour, they could always sell the car. But used auto prices, and especially those of “nearly new” autos, returning to the market after just three years in good condition and with relatively low mileage, are dropping like lead balloons.

Granted, auto lending has increased rapidly: the New York Federal Reserve reported that total auto loans amounted to US$1.17tn in the first quarter of the year (as compared to mortgage loans of US$ 8.63tn), an increase of nearly 70 per cent since the post crisis trough of 2010. Strains have become evident among subprime lenders but also in prime auto debt, forcing banks such as Well Fargo and JP Morgan Chase to retrench.

Adding to the problem, lenders such as Santander Consumer USA Holdings Inc, one of the biggest subprime auto finance companies, verified income on just 8 per cent of borrowers whose loans it recently bundled into bonds, according to Moody’s, a pitifully low standard of due diligence as compared to its competitors.

Despite the gloom, the auto loan delinquency rate remains lower than for other types of debt, such as credit cards and student loans. Just 3.8 per cent of auto balances were 90 days or more delinquent in the first quarter compared with 11 per cent for student loans and 8 per cent for credit cards.

Americans continue to prioritise car loan repayments in a sign of the importance they attach to their vehicles. What’s more, cars are essential for everyday life in the US and are not the speculative investments that houses became a decade ago. Bankers note that overall credit quality remains good and lenders today are also better capitalised. Moreover, the sub-prime auto loan market is a fraction of the size of the sub-prime mortgage market and does not pose a systemic risk to the economy.

US auto producers and finance companies are heading into a very challenging period of adjustment after a 5-year boom. Consumers face tighter lending standards and loan delinquencies look set to rise much further among those with lower credit scores. However, this remains a comparative storm in a teacup.

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