Is there a Subprime Auto Loan Crisis brewing?
4th February 2020
There have been rumblings since 2017 that the auto sector is in trouble. Car sales have stagnated in the US since 2015, and since last year in China. The auto loan backed securities market is bubbling in a race similar to the mortgage-backed securities market in 2006/2007.
The subprime auto-loan-backed securities (ABS) market, which is now showing similar symptoms of the bubble that the housing market did during its collapse in 2007. According to the Financial Times, in an article published in November 2019, issuance of subprime auto ABS was at $29 billion for January through October, putting last years projected totals somewhere around $35 billion depending on the strength of the holiday season, eclipsing 2018’s record of $32 billion. This was despite sales declines of actual cars in 2019 over 2018.
The situation is now reminiscent of the prices of securitized subprime home loans staying elevated for months following the collapse of the subprime loan market in 2007, simply because the ratings on those loans were not officially downgraded until the ratings agencies were forced to do so. Meanwhile delinquency rates are on the rise as sales fall.
As you can see in the chart we have not yet reached the 90-day delinquencies high of 2010 as it reached 5.2% but we aren’t far off. The rate has climbed consistently over the past 5 years and now with falling sales. Obviously 2010 rates where caused by the 2008 crash but we could be looking at even higher rates in the coming months.
It also begs another question: Why are delinquencies on the rise with a strong economy?
Most of the auto loans taken out in 2018 where to individuals described at the ‘’most creditworthy individuals’’ or those with credit scores above 720. But borrowers with credit scores of less than 620 had delinquency rates exceeding 8 percent in the fourth quarter of 2018. This surprised the New York Fed considering the strong economy and labour market.
Economists at the New York Fed wrote in a blog post ‘’The overall performance of auto loans has been slowly worsening, despite an increasing share of prime loans in the stock. The substantial and growing number of distressed borrowers suggests that not all Americans have benefited from the strong labour market and warrants continued monitoring and analysis of this sector.’’
According to the Bankrate survey most Americans haven’t got a pay boost last year. October 2018 average wage had about the same purchasing power as it did 40 years ago, according to Pew Research. As costs continue to rise, wages are struggling to keep up.
Chief financial analyst Greg McBride at Bankrate states that auto loan delinquencies are an accurate measure of financial strain.
‘’Unlike other forms of borrowing, such as credit card debt where the consumer can dial back to a minimum monthly payment if things are tight, with an auto loan there is no wiggle room’’.
Younger people are struggling with loans the most due to the fact that they are less likely to shop around for the best rate of loan. They are also more likely to be struggling with student loans.
So looking forward over the next 12-24 months, we should keep a close eye on the subprime car loan market to see if the bubble bursts.
