One trend throughout 2016 has been certain economists and analysts warning of a bubble developing in the nation's $1 trillion-plus subprime auto loan market, even suggesting that its collapse would harken back to the devastating fallout from the much bigger mortgage market meltdown of the prior decade.
But recent data suggests that while the subprime loan business has ballooned in size, the once-feared spike in defaults and delinquencies has occurred largely among loans offered by auto finance companies, not by banks and credit unions.
Recent data from Experian's
Meanwhile, newly originated loans to prime borrowers increased by 2% to account for almost 60% of all auto loans financed in the third quarter of 2016.
"For anyone making doomsday predictions about a subprime bubble in the auto industry, [the third quarter of 2016] provides a stark reality check," said Melinda Zabritski, Experian's senior director of automotive finance. "This quarter's report shows that lenders are reducing the percentage of loans to the subprime and deep-subprime risk tiers while increasing the percentage to consumers with good credit. The most important takeaway here is to understand the market reality and not to be led astray by rumors or unsubstantiated facts."
The Experian report also underscored that the average credit scores for both new and used vehicle loans are rising: a 712 average for new vehicle loans and 655 for used vehicle loans.
In addition, Experian's research found that credit unions continue to increase their portion of the total auto loan market – a two percentage-point lift from 17.6% market share in the third quarter of 2015 to 19.6% in the third quarter of 2016.
"Credit unions typically have the most competitive interest rates, so any time rates jump overall, it's a natural reaction for credit unions to see a rise in their market share," Zabritski added. "With vehicle prices and loan dollar amounts rising, car shoppers are looking for any relief they can get. Credit unions' traditionally lower rates are obviously an attractive option."
However, a recent quarterly report on
"Subprime and overall auto loan originations remained strong and auto loan delinquency rates were low and relatively flat," the NY Fed wrote. "Yet disaggregating results by credit score revealed significantly higher, and rising, delinquency rates among subprime auto loans."
NY Fed said that the overall 90-plus day delinquency rate (i.e., "seriously delinquent") for auto loans increased only slightly in 2016 through the end of September to 3.6%. "But the relatively stable delinquency rate masks diverging performance trends across the two types of lenders," the NY Fed wrote. "Specifically, a worsening performance among auto loans issued by auto finance companies is masked by improvements in the delinquency rates of auto loans issued by banks and credit unions."
The 90-plus day delinquency rate for auto finance company loans have sunk by a full percentage point over the past four quarters, compared to slight improvements for delinquency rates at banks and CUs.
The report characterized the worsening in the delinquency rate of subprime auto loans as "pronounced," with a notable increase during the past few years.
The data, NY Fed asserted, suggest some "notable deterioration" in the performance of subprime auto loans, meaning some 6 million people are now at least 90 days behind on their auto loan payments. "The increased level of distress associated with subprime loan delinquencies is of significant concern, and likely to have ongoing consequences for affected households," the NY Fed warned.
NY Fed further noted that while banks and credit unions comprise "about half" of the overall outstanding balance of newly originated auto loans, the "vast majority" – about 75% – of subprime loans are originated by auto finance companies.
An Increase, but No Spike
Jason Laky, Senior Vice President-Automotive & Consumer Lending Business at TransUnion, said that while the subprime auto loan market has witnessed an increase in delinquencies, he would not characterize it as a spike – and he also rejected the notion that the market finds itself on the cusp of a bubble. Laky further said that a wave of defaults is unlikely for two principal reasons.
"First, the economy is in pretty good shape," he said. "GDP is growing moderately and we continue to see healthy increases in employment each month. It is hard to see a scenario of mass defaults as long as this is the case." Secondly, he asserted, autos are a necessity for most Americans; without a car, it is difficult to get to work. "As a result, people prioritize their auto payments," he stated. "TransUnion has performed a number of studies on this subject, and we found that, even during the last recession, auto delinquency remained low relative to other credit products."
Even in a worst case scenario, Laky pointed out that subprime consumers represent $172 billion, or just over 15% of the outstanding auto balances reported to TransUnion. "All of the loans are secured by the auto itself, and the industry has a well-functioning auction market that allows lenders to liquidate a default with relative speed and efficiency," he explained. "Even in the worst case, lenders would recover a good portion of the loan principle. Again, absent a concurrent economic shock or recession, the financial system could weather it."
A Contrarian View
However, Brian Turner, president and chief economist at Meridian Economics LLC, warns that defaults and delinquencies among subprime loans have indeed escalated throughout 2016.
"Much of the increase is attributable to [the] collapse in oil prices from last November to early-May this year when average prices fell as low as $24 per barrel," he said. "This hit energy-sector states the hardest, but was felt by others as well. This caused a brief period of layoffs and corporate consolidation that had an impact on consumer wages and net wealth for about nine months. [This was further] complicated by the rising volume of sub-B paper [loans] that [were] issued in 2014 and 2015 by many [financial institutions] – including credit unions – thirsting for loan demand."
In fact, Turner noted, between the third quarter of 2015 and the second quarter of 2016, nearly 60% of newly originated subprime vehicle loans turned delinquent within the first 60 days of issuance. "Subsequently, oil prices have rebounded to $48 to $50 per barrel, but the impact will take a little longer from the consumer to recover until job and wage growth return. For the time being, the jobs that were lost remain on hold."
Tiny Bubbles?
Keith Hopkins, vice president of product support for LEVERAGE, a wholly owned subsidiary of the League of Southeastern Credit Unions and Affiliates (LSCU) which has been developing programs to improve performance for commercial lending or member business loans, said there are indeed some concerns about a potential bubble in the subprime auto loan market.
Citing recent data from Edmunds.com, Hopkins noted that car buyers who are "upside down" – that is, borrowers who are trading in vehicles which are now worth less than what they actually owe on their loans – have hit a new record, rising to 32%, or an increase of nearly 20 percentage points from 2009, when the number stood at 13.9% of borrowers. The previous high was 29.2%, in 2006.
"If the economy goes into a decline this will be the biggest single factor causing defaults to increase," Hopkins said. "We do not see anything at present to suggest that a total economic collapse will occur in this sector."
Still, Hopkins cautions that if the overall U.S. economy experiences another recession it could cause increases in subprime auto loan delinquencies and net charge-offs.
"The impact wouldn't be nearly as bad as what we experienced with the mortgage crisis," he assured. "The biggest issue with the mortgage crisis [was] that [when] a single home… went into foreclosure, [it] could dramatically and rapidly impact the value of entire neighborhoods or communities. With repossessed autos, we do not experience the same impact."
Nonetheless, Hopkins believes subprime auto loans still offer a good growth opportunity for credit unions -- as long as these loans are "properly vetted."
"They can be one of the most profitable [loan products]," he said.
