The automobile market is booming, as the sector recently experienced its strongest sales in six months. Despite car manufacturers thriving from cheap debt, the auto loan market is in a dangerous place right now, with total debt surpassing $1 trillion this year thanks to subprime lending accounting for one-third of the pie. The negative signals might be there, but banks are still trying to get a slice of the pie before it’s too late.
Wells Fargo is returning to the auto lending business after taking a brief hiatus to concentrate on commercial real estate. CEO Tim Sloan confirmed to Bloomberg that the bank will boost lending for car sales after reining in auto financing in late 2016 when they noticed declines in car resale prices that made it harder to recoup losses by repossessing cars should borrowers default. The trade-in treadmill is certainly producing industry-wide headaches, too.
By the end of 2017, the bank’s auto portfolio declined by $8.9 billion year over year to $53.3 billion in total outstanding loans. The outstandings further fell to $49.6 billion in the first quarter of 2018.
Despite the company’s renewed focus in vehicle lending within the next two quarters, Senior Executive Vice President and CFO John Shrewsberry doesn’t anticipate portfolio balances to increase for another two years.
But is this an opportunity to grow the market or to continue adding fuel to the fire?
Auto Loan Debt Growing
The $1 trillion figure might be terrifying, but once you scratch underneath the surface there are even more troubling numbers brewing.
Earlier this year, Experian reported that the average new car loan touched a record high of $31,099, while the typical used car loan reached an all-time high of $19,589. Moreover, borrowers are paying a record monthly average of $515 for new cars and $371 for used cars.
Borrowers can expect to pay more to finance their automobiles as well. In February, the average interest rate was 5.2%, up from 4.9% a year ago.
Analysts are sounding the alarm about affordability, since it’s getting costlier to own a vehicle. Melinda Zabritski, Experian’s senior director of automotive finance solutions, said in a statement:
“I think we’re certainly at a point where affordability is a question. When you look at how much income you need to support that payment, it certainly is higher than your average individual income.”
For years, auto dealers used the power of 0% financing to boost sales. This technique may finally come to an end, but it’s being substituted for subprime.
Could Subprime Cause Trouble?
The subprime market should worry investors, the auto industry, and politicians. Like the role subprime played in the mortgage crisis a decade ago, it could have a crucial part in the auto sector’s demise.
Subprime auto loans represent $300 billion of the entire market. What’s worse is that borrowers with low credit scores of under 600 are getting their hands on these loans, and it is already spelling trouble for lenders.
According to new data from Fitch Ratings, customers are defaulting on their subprime auto loans at a higher rate than during the economic collapse. In March, the delinquency rate, which is more than 60 days past due, hit a 22-year high of 5.8% – the default rate in 2008 was just 5%. This comes as the Federal Reserve Bank of New York ignited widespread panic in February when it warned that more than six million borrowers were at least 90 days late on their repayments.
To combat the trend, financial institutions are financing fewer subprime applicants, raising lending standards, and reducing loans to subprime clients by 10%. But is it a case of too little too late for some smaller firms?
In April, Bloomberg reported that smaller subprime lending outfits are folding because of slim margins and losses on loans. It listed Summit Financial Corp., Spring Tree Lending, and Pelican Auto Finance as businesses that have closed their doors or on the verge of shutting down.
The business news network wrote:
“The pain among smaller lenders has parallels with the subprime mortgage crisis last decade, when the demise of finance companies like Ownit Mortgage and Sebring Capital Partners were a harbinger that bigger losses for the financial system were coming. In both cases, rising interest rates helped trigger more loan losses.”
Although skeptics see something ominous, others note that the subprime industry typically travels through cycles. In the 1990s, benefiting from easy money, the industry blossomed. However, 41 lenders filed for bankruptcy, closed, or were purchased by competitors by 1999. Today, it might be enduring tightening, but you can’t tell that to bigger private equity firms, like Blackstone, that are expanding their presence in the market.
The Bubble Will Burst
Since the recession, the Federal Reserve has helped form multiple bubbles in the national economy. From real estate to classic art to technology stocks, it seems everything more is valuable than the fundamentals would suggest. Because of record-low interest rates for several years and the central bank printing trillions of dollars, easy money and cheap debt has seeped into many markets, which gives us the illusion that happy days are here again. Faustian economics will eventually burst our bubble and auto loans, particularly subprime, may be the first casualty.
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