Lambert here: Last time around houses, now cars, next time around car stereos and rims, I would think. What next?
By Wolf Richter, a San Francisco based executive, entrepreneur, start up specialist, and author, with extensive international work experience. Originally published at Wolf Street
New vehicle sales in the US have been on a tear in 2014, rising 5.6% to 16.5 million units, the highest since banner year 2006. Light-truck sales jumped 10%, cars edged up 1.8%. The industry is drunk with its own enthusiasm.
General Motors CEO Mary Barra sees “still plenty of room for the auto industry to grow.” She rattled off politically correct reasons: consumers who’re “feeling pretty good about the future,” due to “the strength of the labor market, better job security and the recovery in home prices,” topped off by the “sharp drop in fuel prices and rising incomes,” possibly confusing them with her rising income.
So sales could hit 17 million in 2015, she said in the statement. It would take the industry back to the car-glory days of 2001. It’s going to be younger buyers – the Holy Grail of everyone. They’re not just moving out of their parents’ homes, where they’ve been holed up for years because they can’t afford the soaring rents or home prices, but now they’re also going to splurge on a set of wheels. Because it’s a great time to buy.
Interest rates for six-year new-car loans are as low as 2.75%, according to Bankrate.com. Loan terms can be stretched to seven years, to where these younger buyers will be awfully close to middle-age before they finally get out from under it. Loan-to-Value ratios have soared well past 100%; everything can be plowed into the loan: title, taxes, license fees, cash-back, and the amount buyers are upside-down in their trade. The package is governed by loosey-goosey lending standards. Bad credit, no problem.
And that’s exactly the problem.
Over 8.4% of subprime auto loans taken out in the first quarter of 2014 were already delinquent by November, according to an analysis of Equifax data by Moody’s Analytics for the Wall Street Journal. That’s the highest rate of early subprime delinquencies since Financial-Crisis year 2008.
Stuffing people into cars they can’t afford and ultimately may not be able to pay for is big business. Auto loans to subprime borrowers (credit scores below 640) make up over 31% of all auto loans, according to Equifax. Outstanding loan balances have soared nearly 17% over the last two years. At this rate, they’ll breach the $1-trillion mark by the end of the first quarter this year.
In broader terms, 2.6% of the auto loans taken out in Q1 2014 were delinquent by November, the highest rate of early delinquencies since crisis-year 2008, when they rose above 3%.
The bailed-out former auto lending unit of bailed out GM, Ally Financial, now the largest non-captive auto lender, reported $355 million in nonperforming auto loans in Q3 2014, up 8% from a year earlier. And during the first three quarters, it charged off as uncollectible $341 million, up 18% from the prior year.
Santander, one of the top 15 auto lenders in the US, discovered that it’s overall auto-loan delinquency rate in Q3 was a vertigo-inducing 16.7%, highest in the nation, followed by Capital One’s delinquency rate of 6.6%.
But there’s nothing to worry about.
“Auto loans continue to perform well, as they did during the recession,” explained Bill Himpler, Executive VP of the American Financial Services Association, a lobbying organization for the consumer credit industry, including auto lenders. “Concerns about a spike in delinquencies have not been substantiated by evidence,” he said to mollify our concerns, echoing Equifax’s soothing statement in October that “a bubble is not occurring” in subprime auto lending.
Regulators beg to differ.
“We’re putting banks on notice that we have concerns,” Darrin Benhart, deputy comptroller of supervision risk management for the Office of Comptroller of Currency, told the Wall Street Journal. They’re worried about the lackadaisical lending standards and extended loan terms, and about the high interest rates for subprime borrowers who don’t have other options. “It’s definitely an area that warrants some attention,” he said.
The subprime lending tactics of Ally, GM’s new captive lender GM Financial, and Santander have come under investigation by the Justice Department last year. And even as some of the bigger lenders are trying to be a little less aggressive with subprime loans, smaller lenders are jumping into the fray.
“Subprime delinquencies and losses are beginning to grow at a more rapid pace than we’ve seen in a long time,” said Kevin Duignan, global head of securitization for Fitch Ratings.
Lenders are on the hook for nearly $1 trillion in auto loans. A good part is subprime, and if the subprime bubble blows up, losses will hit these banks, and they’ll bleed, and their stocks will swoon, but it won’t take down the megabanks. The amounts aren’t big enough. A specialized lender or two might sink, and nerves on Wall Street would get rattled until a member of the FOMC tells Bloomberg TV that QE4 might be a possibility, which will jar stocks back into rally mode. But it won’t bring down the financial system.
Lenders, while licking their wounds, will tighten lending standards and shorten terms, and they’ll keep an eye on LTV ratios and credit scores. With shorter terms, payments jump. And with limits on LTV ratios, people who’re upside-down in their trade, have no cash, and want title, taxes, and license fees rolled into the deal, have trouble financing a new car.
These aren’t just a few individual cases, but much of the hollowed-out, over-indebted, underpaid middle class, the new American proletariat, the 62% of the population that has no emergency savings to cover a $500 car repair or medical bill. These households face, as the Federal Reserve said last year, “large-scale financial strain.” They’ve been bypassed by the Fed’s “wealth effect.” And with tighter lending standards, many of these folks won’t be able to buy a new car.
Auto sales have been a big force in boosting retail sales, consumer spending, manufacturing, transportation (trucking, railroads), and service activity. So when the auto subprime bubble pops, it won’t take down the financial system; but it will hit the broader economy.
Let’s hope – knowing that hope is not a strategy – that it doesn’t pop in synch with another debt-fueled economic miracle, now imploding, the shale oil and gas boom. Because that would knock down in one fell swoop the two major growth industries that have largely been responsible for whatever “recovery” we’ve had in the US. Read… Oil-Bust Bloodletting: Projects Cancelled, Layoffs Ripple to Other Areas, Default Hits Private-Equity and Pension Funds
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Good article, but it would have helped if Richter told us how many of these dodgy loans have been bundled into ABS and levered up to the max.
Can anyone answer that question?
I don’t the exact answer to that question; however, I do know that Wolf Richter and Yves Smith (on this blog) have both noted that the size of the subprime auto loan market isn’t sufficient to blow-up the economy alone, so we wouldn’t see anything nearly as dire as what happened in 2008.
However, I’ve recently seen a few predictions that if a meltdown in the subprime auto loan market were to happen concurrently with something else–the most cited examples seem to be related to falling oil prices–that we could see disaster on par with 2008, but who really knows at this point?
Oil, is made through investment rather than finance, it can’t take down anything. This so called “auto-subprime” only makes up of 10% of sales in a shallow market. Put it this way, if you had a dog and it could bite, but was lacking teeth, what would it feel like?
I would argue the “auto-subprime” bust would be on par with the 1998 RE subprime bust………yeah, the one that nobody remembers. Trying hard to find crashes will be a painfully “Ahab” moment. Especially after the 07-08 financial crisis. Everybody is more conservative until you can regain confidence long term. Instead, we get “mini” speculatory micro-areas like Oil where finance can scrap for extra cash on the side. In otherwords, we need the boom before the bust.
Interesting commentary on oil given that many regional banks have double digit percentages of their overall loan inventories in oil – likely shale.
I also wonder just how much of Santander’s bad loans are Uber related – as that bank was a partner in Uber’s “loan to drive for Uber” program.
I see an auto loan crash having a disproportionate effect two ways: 1) The pervasiveness of the automobile in the US economy. It won’t just affect manufacturers, lenders, dealers, etc. and their employees, it will also affect the ability of your workforce to get to your worksite and the ability of your customers to get to your store; 2) We will have run through our two, great, leveraged purchase assets, homes and cars, to use as bubble originators and will have to come up with something totally new. I’m predicting food; we’ll soon enter into collateralized loan agreements to buy groceries. And since the security interest follows along through an y transition in the asset, the lenders will be able to say quite literally this time that their collateral was simply flushed away.
Lsst time I checked the total market for auto-related securities was around $180 billion.
Well, gotta have someplace to live when your parents lose ***their*** house. Next, 30 year ARMS for cars?
Option Arms
Given how long cars and pickup trucks now last, anything above 15 or 16 million sales a year on an extended basis is unreasonable.
I thought my Chevy Duramax mothership was expensive when I bought it in 2002, and I swore I would never buy another new pickup. 280,000 miles later, it just had its fuel injectors replaced, and it’s like a new truck again.
This was its first major repair.
I experience something like a cross between dread and anxiety when I look at new pickup prices. Who is paying that? There’s only so many hospital administrators in this town.
The thought that central planning has an eye on this is comforting. Since the crash of ’08 the only focus has been on propping up the financial sector. You really only have to watch the theatrical round-robinning of central bank liquidity puts to understand the manageable aspects of any sub-prime crunch. The knock-on effects of simultaneous downturns would, in view of other related accommodations, not be the end-all, as Wolf correctly pointed out.
Resistance is futile, you will be assimilated
This latest subprime debacle is interesting not because it is another bubble but because the auto industry has been the backbone of the American economy since 1945. Not only is America based on auto economics for transportation, but for the whole obnoxious lifestyle that spins around it. Bernanke himself pretended to be proud that the economy was getting stronger because auto sales were taking off. Because of credit, of course. But nobody in their right mind (if anyone is left with one) can buy this synthetic happiness any longer. It is nothing more than runway foam. America needs to at least look like it is functioning, and if a fake economic burst of auto buying serves that purpose, then fine. After the dust settles, and all the cars are repossessed and rusting on tattered used car lots, and big auto franchises are all boarded up, the great American auto industry will finally rest in peace.
Doesn’t look like it will happen that way. For many in the lower economic classes you may be right but most people won’t default on their loans–there are people who live for credit scores and won’t risk them. They’ll sell their kids into slavery before defaulting on a loan.
I wonder if the auto-makers are installing automatic shut off levers to be shut-off when the delinquency is over 90 days? Will we see single mothers stranded on freeways? Will we see elderly people stranded at grocery stores? Will we see Gen Y stranded at midnight after bar runs?
I could be wrong about this but I my understanding has been that such technology only works the next time you try to start the car: i.e. if the whomever owns the car–bank, dealership, etc–activates the disabling feature when you happen to be driving, the car won’t suddenly shut off and crash. Rather, when you park and shut the engine off, you won’t be able to start it up again.
I think you’ll see lots of creativity put to good use.
Big difference between cars and subprime mortgages. Abandoned cars have no residual value upon which to ‘foreclose’ when they can’t start. Consumers walk away or take down the civil court system.
Great article. I would also add that a significant source of the problem is the fact that the US has made it all but impossible for individuals to function in society without owning a car. That’s something that has to change, though it would require confronting our nation’s toxic car culture.
There are pockets of the United States where it is possible to live sans car, mostly in major cities; however, in the aggregate they are far and few between. The biggest impediment to changing this is political and social: the default assumption among many people in this country is to consider any adult who doesn’t drive as suspect.
Yes, there are people who have had multiple DUI’s—it practically takes an act of Congress to lose your driver’s license for being irresponsible—but there are also a number of people who can’t drive through no fault of their own: e.g. legally blind, epilepsy/seizure disorder that isn’t completely controlled, etc.
Barring such people from driving is a necessary evil; however, most parts of this country do a poor job of providing alternatives. If you can’t drive, even if it’s for reasons that have nothing to do failings of personal responsibility—I know at least one person who can’t drive because of a medical condition—you find that many doors are closed.
It’s been noted that 20% of the US population doesn’t drive or own a car (too young, old, infirm, poor, or principled). Those whom have spent a lifetime driving find it very isolating when auto-mobility fades. They haven’t a lifetime’s experience with mass transit and shuttle services. And the suburbs aren’ set up for walking. Although electric bikes may become a reasonable solution for some.
Much depends on the spread between what lenders are charging in interest and what their costs are. Big lenders can afford high delinquency rates and not burn and crash. As far as I can see even if delinquencies rise even more I don’t see “the economy” taking a big hit. I do see people at the bottom end of the economic spectrum taking a big hit but they don’t count because not only do they tend not to vote but that they are also isolated and unorganized.
Now, if this stuff is combined with the oil crash and other problems in world markets then we might have some trouble since there are so many derivatives out there–but my impression is that hedges on hedges on hedges all “guaranteed” by sovereign funds and the Fed should cushion a lot of the risk.
We have an economy organized for a gradual transition to serfdom and things continue as planned.
A wobble in the auto sales system would affect my Ky county big time – Toyota is here and is a MAJOR employer, along with countless satellite factories, and of course, the knock-on effects on local commerce. We make the high-end Lexus, as well as the Camry. A LOT of locals depend on Toyota for their jobs – and we are one of the most prosperous counties in the state. Consumers here battened down the hatches after the Great Crash, and are just now peeking out of their shells. Another downturn would have them snapping shut their pocketbooks instantly. Not good for Scott County.
Don’t worry, Yellen does not see any bubbles while sitting on her own bubbly balance sheet and assuring us that macro-prudential instruments are the way to go.
Relax…the American student loan crisis will start soon..auto loans will be the least of our worries. Maybe we can bundle the two ( auto loans and student loans) into risky derivatives and get the US Congress to bail us out.