The subprime market was always destined to collapse under the weight of defaults, delinquencies, and destitution. Like everything else in the global covidepression, the subprime industry contracted the respiratory illness, and experts are considering transferring this segment of the economy to the intensive care unit. The debt-laden marketplace shall soon learn if the patient will survive or perish. Either way, it is terrible news for the broader economic system that emphasizes value over risk – for now.
Start Your Subprime Engines
Subprime represents a considerable portion of the overall auto loan market. The latest numbers suggest that about 20% of all new loans were extended to subprime borrowers, topping $61 billion. Lenders have compounded the problem by expanding the length of these loans, averaging short of 73 months. Before the emergence of the Coronavirus, there was a trade-in treadmill trend – vehicles with little to no equity – and incremental growth in delinquencies.
This was a recipe for disaster in a downturn. Sure enough, the fault lines are beginning to form.
Credit Acceptance Corporation, a large subprime auto lender, is sounding the alarm. In a recent regulatory filing, the company announced that it is starting to notice a steep decline in borrowers skipping loan payments. As unemployed borrowers shift their financial priorities, it would make sense that car payments would fall in household ranking systems.
"A continued disruption in our workforce, decrease in collections from our consumers or decline in consumer loan assignments could cause a material adverse effect on our financial position, liquidity and results of operations,” Credit Acceptance wrote.
It is not just delinquency payments creating a headache for the U.S. economy. New data from Edmunds.com, an American online resource for automotive information, revealed that negative equity is prevalent in the new- and used-vehicle market. The numbers noted that the average amount of subzero equity was $5,225 for a new automobile and $3,873 for used cars in March. Overall, just under one-fifth of all new-vehicle sales possessed negative equity.
Just because the showrooms are closed does not mean auto manufacturers and dealers are coming up with clever ways to initiate sales. Companies are presenting multiple incentives, including deferred payments and length of terms, to stay afloat and pad their monthly receipts,
And this is when you get the trade-in treadmill, warned Edmunds' executive director Jessica Caldwell in an interview with SubPrime Auto Finance News:
"Generous financing offers from automakers such as zero percent for 84 months make sense for responsible consumers who intend to keep their vehicle until the wheels fall off. However, many consumers get the itch to trade in and make a new purchase much sooner, so longer loan terms could lead more individuals down a road toward negative equity.
“Vehicle popularity often shifts in the U.S. to meet changing consumer preferences, which could also negatively impact the value of these vehicles."
While it is difficult to measure just how bad the market is due to forbearance, the subprime auto lending industry may enjoy temporary financial relief because of the Federal Reserve. Since the U.S. central bank announced that it would expand its quantitative easing blitzkrieg to include exchange-traded funds (ETFs), the Fed is inevitably going to scoop up an investment that is exposed to junk bonds that are then tied to subprime auto packages.
Subprime Shelter in Place
Forbearance, skipped payments, and delinquencies – this is the new normal for the U.S. real estate market. Is it a bit premature to declare a mortgage crisis comparable to 2008’s? If three million Americans have missed their monthly payments, then trouble is brewing in a market that is drowning in red ink worth $15.8 trillion. Suffice it to say, volatility is ubiquitous in housing right now, and if there is one part of the industry that cannot endure chaos, it is subprime.
For the most part, banks have done an admirable job of keeping the lid on subprime mortgages over the last decade. Many lenders have indeed reduced their underwriting standards and offered liar loans – minimal income and document verification – moves that are reminiscent of the housing bubble of 15 years ago. But a lot of financial institutions have been running tight ships – mostly. Of the overall $11 trillion mortgage market, subprime accounts for about $2 trillion, which is still a large chunk of change.
The U.S. housing market is bracing for a drop in prices after it was reported that existing-home sales declined 8.5%, construction spending slipped 0.8%, and investment in private residential projects slumped 1.8%. What makes these numbers interesting is that the declines occurred before most states implemented stay-at-home orders.
The National Association of Realtors (NAR) says the worst is yet to come because we are only starting to scratch the surface of COVID-19's impact on the real estate market. The March figures represent sales that were completed in January and February before the Coronavirus crashed financial markets, so anticipate a Black April.
If there is one thing subprime cannot handle, it is a decrease in housing prices. Borrowers are missing payments, and they will add up and need to be repaid. Lenders will inevitably foreclose in the future and possess homes that maintain lower resale values. In other words, expect a bloodbath in the housing data over the coming months.
On Borrowed Time
During the bust and boom phases of the business cycle, homeowners have used their humble abodes as ATMs with real estate equity worth more than $6 trillion, or $140,000 per person. This would be handy cash for millions of Americans out of work, furloughed, or scraping by in their paycheck-to-paycheck existence. The banks are tightening their credit standards out of fear they may not be repaid, and other financial institutions are temporarily pulling back from mortgage lending. Even before the Coronacrisis, there were cracks in the foundations, the fundaments were unsound, and everything was and still is debt on top of debt. The American dream had always been to own a home with a white picket fence, but it has metastasized into an American nightmare as one-third of homeowners cannot afford their property. Not only is it hard to get into the market, but once you are in, you may have to venture through the nine circles of hell inside Dante’s Inferno to enjoy your four-bedroom semi-detached that has a man-cave, heated floors, and a kitchen island.
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Read more from Andrew Moran.
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