Should credit unions more aggressively court subprime borrowers for auto loans? Or is that merely courting the next disastrous "bubble?"
In a report that was inspired by numerous reports suggesting that a dangerous bubble is forming in the subprime auto loan market similar to the conditions that presaged the mortgage meltdown, Equifax Inc. seeks to debunk those claims.
In a report entitled "Subprime Auto Loans: A Second Chance at Economic Opportunity," economists at the Atlanta-based global information company studied two groups of consumers with deep subprime credit scores (below 550): one group that originated subprime auto loans, and one that did not.
Equifax discovered that after a three-year period, consumers with deep subprime credit scores who originated a subprime auto loan exhibited, in the aggregate, a significant increase in their credit scores. Specifically, their credit scores jumped by an average of 52 points — a 62.5% improvement over the group that did not take out such an auto loan.
Moreover, the group that took out a subprime auto loan demonstrated a far greater likelihood — four times as much — of upping their credit score above 640 (which would move them out of the subprime range), versus the group that did not take an auto loan.
"The auto industry's success wouldn't be what it is today if it weren't for the responsible, solid subprime loans made to... many Americans," said Equifax's chief economist Amy Crews Cutts and deputy chief economist Dennis Carlson, in a statement. "Lenders now have better tools, more data and enhanced technology available to them to make sounder and safer decisions. While we should all continue to remain vigilant, we can confidently say that subprime auto lending is currently performing well, it's not growing as quickly as prime lending, and our data does not suggest that a bubble is forming."
The Equifax report runs counter to a number of reports in the mainstream media warning of a massive bubble forming in the subprime auto loan sector, including New York Times report that found conditions developing in subprime auto loans to be comparable to the conditions that presaged the meltdown of the mortgage market a few years ago.
But Equifax suggested such media reports were only looking at the worst-case scenarios of customers with subprime auto loans and inaccurately portrayed predatory practices and poorly-originated lending as the "norm" for all subprime lenders when the actual data does not support such dire assessments.
"The numbers show that subprime auto lending has been delivering a viable second chance for many consumers who fell on hard times during the recession, and have since been struggling to rebuild their financial and credit risk standing," Equifax stated. "Our data also shows that subprime is a well-managed and stable subset of automotive lending—a subset that has been a key driver of our overall economic health."
Indeed, Equifax data revealed that prime lending is growing at more than double the rate of subprime lending. Specifically, the number of auto loan originations for consumers with nonprime credit scores edged up only by 2.4% from 2013 to 2014, while the number of originations for consumers with prime and super-prime credit scores jumped by 5.1% during the same period.
"Unlike the wildfire growth of the housing market and subprime and non-traditional mortgages from 2004 through 2008, subprime auto lending has consistently grown at a controlled, steady pace," Equifax stated.
Moreover, Equifax noted, comparing auto lending to mortgages is not an apples-to-apples comparison.
"There are vast differences between the automotive and housing industries," the firm stated. "A car is a depreciating asset that is often essential for everyday family mobility and employment. Very few borrowers — other than perhaps vintage car collectors — originate an auto loan expecting to resell the vehicle two years later for profit, and, as such, there is little incentive to take on an unaffordable loan. Yet this was exactly the behavior many consumers had exhibited prior to the burst of the housing bubble."
Thus, the "bubble" in subprime auto loans, the authors conclude, is a "fiction."
"There is no definitive evidence that suggests an auto subprime loan bubble similar to the housing bubble is forming," the authors said.
In an interview with Credit Union Journal, Carlson, one of the report's authors, said Equifax was motivated to conduct this study about a year ago in response to the plethora of media reports suggesting that a harmful bubble was building within the subprime auto loan market.
"We went into it thinking that premise was overblown, but we wanted to back it up with hard data and facts that might counteract that notion by looking at the entire market," he said. "We found that the business is actually quite stable and growing, while media reports seemed to focus on anecdotal incidences of misfortune."
Carlson said that what most surprised him was that more than one-fourth of a sample of deep subprime borrowers who took out an auto loan in June 2010 improved their credit score by an extraordinary 100 points or more by June 2013.
"I think what this report shows is that people with imperfect credit scores should not be demonized," he noted. "We have seen that subprime borrowers can only improve their credit scores if, in fact, they get a loan in the first place. If they can't get such a loan, they can't get their finances in order."
While Carlson would not comment specifically on credit unions, he said that the Equifax data shows that lenders have been and are continuing to safely loosen some of their lending standards in order to give subprime customers a chance at proving their ability to make repayments on time.
But should CUs delve more deeply into this arena?
Keith Troup, executive vice president and chief operating officer at Y-12 Federal Credit Union, a $750-million institution based in Oak Ridge, Tenn., and a member of the CUNA Lending Council Executive Committee, told Credit Union Journal that credit unions have generally been risk-averse when it came to handing out loans, particularly autos.
"I think we are gradually now seeing credit unions become a little more aggressive in taking on borrowers with less-than-perfect credit scores," he said.
At his Y-12 credit union, Troup estimates that, as of 2014, about 10% of its auto loans were issued to non-prime borrowers — and that figure has increased slightly from the prior year.
A report late last year from National Credit Union Foundation (NCUF) revealed that of the 8 million used cars sold annually to low- and moderate-income borrowers, credit unions financed only 5% of those vehicles, while subprime lenders financed about 60%, suggesting a huge potential opportunity for credit unions.
Indeed,
