Here They Go Again----Subprime Delinquencies Rising In Autoland

Yesterday's WSJ article on rising auto loan delinquencies had a familiar ring. It focused on sub-prime borrowers who were missing payments within a few months of the vehicle purchase. Needless to say, that's exactly the manner in which early signs of the subprime mortgage crisis appeared in late 2006 and early 2007.

More than 8.4% of borrowers with weak credit scores who took out loans in the first quarter of 2014 had missed payments by November, according to the Moody’s analysis of Equifax credit-reporting data. That was the highest level since 2008, when early delinquencies for subprime borrowers rose above 9%.

To be sure, subprime auto will never have the sweeping impact that came from the mortgage crisis. The entire auto loan market is less than $1 trillion compared to a mortgage market of more than $10 trillion at the time of the crisis.

Yet the salient point is the same.The apparent macro-economic recovery and prosperity of 2004-2008 rested on the illusion of an unsustainable debt fueled housing boom; this time its the auto sector.

Indeed, delete the auto sector from the phony 5% GDP  SAAR of Q3 2014 and you get an economy inching forward on its own capitalist hind legs. Q3 real GDP less motor vehicles was up just 2.3% from the prior year (LTM); and that's the same LTM rate as recorded in Q3 2013, and slightly lower than the 2.4% growth rate posted in Q3 2012.

Aside from autos, there has been no acceleration, no escape velocity. Furthermore, the 2%+/- growth in the 94% balance of the economy after the 2008-09 plunge has nothing to do with the Fed's maniacal money printing stimulus and the booster shot from cheap credit that is supposed to provide.

The reason is straight forward. There is no such thing as Keynesian monetary magic. Central bank interest rate repression either encourages households to supplement income based spending with incremental borrowings--- or it has no direct impact on measured GDP.

The fact is, outside of autos and student loans, households have reached peak debt. That is after a 30-year spree of getting deeper and deeper into hock, middle class households stopped adding to leverage on their wage and salary incomes at the time of the financial crisis; and since then they have actually deleveraged slightly---albeit at levels that are still way off the historical charts.

Household Leverage Ratio - Click to enlarge

Household Leverage Ratio - Click to enlarge

But underneath this aggregate---which includes all forms of household debt including mortgages, credits cards, auto and student loans etc.---- there has been a sharp bifurcation of trend since the pre-crisis peak in 2007.

Home mortgage debt is down by $1.1 trillion or 9% from its late 2007 peak in absolute terms, and even more dramatically as a ratio against income.

US Mortgage Debt Chart

US Mortgage Debt data by YCharts

Likewise, household credit card and revolving debt---after decades of rising in absolute terms and as a ratio  to income---is also down significantly. Stated differently, after 73 months of ZIRP, households have not responded to the Fed's parlor trick. Not withstanding aggressive marketing by credit card companies, credit-worthy households have exercised restraint, while the vast majority of mainstream households which live hand-to-mouth have remained too credit-impaired to borrow.US Credit Card Debt Chart

US Credit Card Debt data by YCharts

By contrast, auto debt outstanding has fully recovered and soared to record levels. And the reason is not hard to find.

Car loans are collateralized and recoverable by the repo man when borrowers fail to pay. But unlike the case of housing, there has not yet been a crash in the value of new and used vehicles. So lenders---and especially the big banks like Chase and Wells Fargo----have had a field day making auto loans and either funding them with essentially zero cost deposits or selling them at an instant "gain-on-sale" profit to the securitized paper market.

Consequently, auto loans outstanding are up nearly 30% from the post-crisis bottom, and nearly 20% from their prior peak. In short, the near total recovery of auto sales rests on a trillion dollar mountain of debt.

US Auto Loan Debt Chart

US Auto Loan Debt data by YCharts

Here's the thing. On the margin, much of the recent growth of auto sales has been attributable to sub-prime borrowers, which are now up to 31% of all loans. These loans carry onerous interest rates---often 20% or more----and are available primarily due to junk debt financing of non-bank lenders. That is, fly-by-night start-ups organized by Wall Street and private equity funds.

Eventually, the soaring default rates described in the attached WSJ article will infect the entire auto market----just as did the implosion of sub-prime mortgages last time around. When the volume of defaults and repossessions gets high enough, the used car market will falter, and the food chain of auto sales will fail.

And that means that the Fed's sole success in stimulating uneconomic lending will come ricocheting right back into the recorded GDP.  Stated differently, the V-shaped recovery in auto sales is undoubtedly the last hurrah for the Fed's maniacal embrace of ruinous printing press economics.

US Vehicle Sales Chart

US Vehicle Sales data by YCharts


By Alan Zibel, Christina Rogers And Annamaria Andriotis at The Wall Street Journal

Borrowers who took out auto loans over the past year are missing payments at the highest level since the recession, fueling concerns among regulators, analysts and some in the car industry that practices that helped boost 2014 light-vehicle sales to a near-decade high could backfire.

“It’s clear that credit quality is eroding now, and pretty quickly,” said Mark Zandi, chief economist at Moody’s Analytics.


More than 2.6% of car-loan borrowers who took out loans in the first quarter of last year had missed at least one monthly payment by November, the highest level of early loan trouble since 2008, when such delinquencies rose above 3%, according to an analysis of data performed for The Wall Street Journal by Moody’s Analytics.

The uptick comes amid an increase in subprime auto loans, raising concerns that car buyers may have taken on more debt than they can handle. For that set of borrowers, defined as consumers with a credit score lower than 620, loan performance also is deteriorating.

More than 8.4% of borrowers with weak credit scores who took out loans in the first quarter of 2014 had missed payments by November, according to the Moody’s analysis of Equifax credit-reporting data. That was the highest level since 2008, when early delinquencies for subprime borrowers rose above 9%.

Car lenders say the concerns are overstated. “Auto loans continue to perform well, as they did during the recession,” said Bill Himpler, executive vice president of the American Financial Services Association, which represents auto lenders. “Concerns about a spike in delinquencies have not been substantiated by evidence.”

Overall auto-loan delinquencies have been running above year-ago levels but remain lower than during the recession. As of the third quarter, 3.4% of borrowers had missed at least one car-loan payment. That was up from 3.2% in the same quarter a year earlier but still below 4.2% in 2009, according to Experian Automotive.

Consumer advocates, meanwhile, say car dealers and finance companies are being overly aggressive with low-income borrowers, pushing them to the limits of what they can afford.

They point to borrowers like Patrina Thomas, 48 years old, from the Syracuse, N.Y., area. She said she was persuaded by a local car dealer to trade in her 2002 Jeep in the summer 2013 in favor of a used 2008 Chrysler Sebring, sold for more than $17,000 and financed with a 20.4% interest rate. Unable to make the $385-a-month payment, the car was repossessed last year.

“Now my credit is ruined,” said Ms. Thomas, who still owes more than $7,600 on the car. “I can’t buy a house for a while.”

Ms. Thomas’s auto loan was financed by Chrysler Capital, a joint venture between the auto maker and Santander Consumer USA Holdings , a unit of Banco Santander SA.

A spokeswoman for Santander declined to comment on the case or on the company’s delinquency rates.

According to third-quarter 2014 data from Experian, the industry leaders, excluding financing arms of car manufacturers, are Ally Financial Inc., with 7.31% of new-car loans, J.P. Morgan Chase & Co. with 5.96%, Capital One Financial Corp. with 4.38%, Wells Fargo & Co. with 3.46% and TD Bank with 2.33%. In the used-car market, the leaders are Wells Fargo at 6.56%, Ally at 4.41% and Capital One at 4.35%.

Ally Financial reported $355 million of its outstanding consumer car loans as nonperforming as of Sept. 30, according to its Securities and Exchange Commission filing. That is up 7.9% from the end of 2013. Its net charge-offs for car loans—the amount it is writing off as a loss because it doesn’t expect to be paid back—were $341 million for the nine months ended Sept. 30, up 18% from a year earlier.

The increase in losses “is related to growth in the consumer portfolio as well as our strategy to diversify the business and book a more balanced mix of assets,” said Gina Proia, a spokeswoman for Ally. “The increase in losses was expected and in line with our expectations. We continue to have a robust underwriting policy and price for risk appropriately.”

Of the 15 biggest U.S. auto-lending banks, Santander had the largest percentage of delinquent auto loans in the third quarter, according to SNL Financial. Santander’s delinquency rate of 16.7% was followed by Capital One at 6.6%, according to SNL.

In general, the auto-finance sector is one of the fastest-growing lending markets since the financial crisis, with outstanding loan balances hitting $943.8 billion at the end of September, from $809 billion two years earlier, according to the Federal Reserve.

Since such loans have performed well in the past, lenders have been more willing to take risks on auto lending, while staying cautious on home mortgages, analysts say.

Of particular concern are loans in which car dealers push financing at extended terms of six and seven years at relatively high interest rates, even if the borrowers have weak credit and escalated debt-to-income ratios. The longer loan terms keep monthly payments under control and get buyers to purchase more expensive cars.

Low-interest rates and wider credit availability have helped propel the U.S. auto industry’s comeback from the recession, driving new-car sales to 16.5 million last year, the highest level since 2006, according to market researcher Autodata Corp.

To keep the momentum going in 2015, industry analysts said car companies and lenders will likely have to push more aggressive finance deals and tap borrowers with weaker credit. Riskier lending tactics already are drawing regulatory scrutiny.

Federal bank regulators observed that lenders were weakening standards and taking on more risks about two years ago, said Darrin Benhart, deputy comptroller of supervision risk management for the Office of Comptroller of Currency, which regulates the largest U.S. banks. “We’re putting banks on notice that we have concerns,” Mr. Benhart said. “It’s definitely an area that warrants some attention.”

Several state and federal agencies also are investigating industry practices, particularly for subprime borrowers. The Justice Department last year sent subpoenas to Ally, General Motors Financial Inc. and Santander Consumer USA. The subpoenas ask them to turn over documents related to subprime-lending businesses.

Kevin Duignan, global head of securitization for Fitch Ratings, said some bigger lenders are starting to pull back and be more conservative on subprime auto lending. The credit-rating firm is concerned that small and midsize lenders won’t follow suit and dive too deeply into subprime lending.

“Subprime delinquencies and losses are beginning to grow at a more rapid pace than we’ve seen in a long time,” he said.

Losses on securities backed by prime and subprime auto loans were up in November, with subprime reaching levels not seen since early 2010, according to Fitch.

Car loans didn’t experience the surge in defaults that occurred in mortgage lending during the recession. If a loan does goes bad, it is easier to repossess and resell a car than a house or office building.

The rise in delinquency rates shouldn’t be surprising given the rebound in subprime lending, said Melinda Zabritski, director of automotive credit for Experian. Lending to below-prime borrowers accounted for about 23% of the vehicle-finance market in the third quarter, up from 21% in 2009 but still below pre-recession levels of 28% in 2007, according to Experian.

Compared with the low point of six years ago, growth in such lending, “may look extreme, which is why we recommend looking at a longer view,” Ms. Zabritski said.

Some auto-industry executives are nervous, saying the riskier practices can leave consumers upside down on their loans longer, owing more than their vehicle is worth when they are ready to trade in.

“The industry is starting to do some stupid things,” said John Mendel, Honda’s America’s vice president of sales. The longer-term loans coupled with greater use of subprime financing can leave buyers paying interest rates as high as 22%, much higher than what is typical for prime buyers, he said.

“If you’re going to trade in in the next six years, you’re going to have a problem,” Mr. Mendel said.

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