New vehicle sales in the US have been on a tear in 2014, rising 5.6% to 16.5 million units, the highest since banner year 2006. Light-truck sales jumped 10%, cars edged up 1.8%. The industry is drunk with its own enthusiasm.
General Motors CEO Mary Barra sees “still plenty of room for the auto industry to grow.” She rattled off politically correct reasons: consumers who’re “feeling pretty good about the future,” due to “the strength of the labor market, better job security and the recovery in home prices,” topped off by the “sharp drop in fuel prices and rising incomes,” possibly confusing them with her rising income.
So sales could hit 17 million in 2015, she said in the statement. It would take the industry back to the car-glory days of 2001. It’s going to be younger buyers – the Holy Grail of everyone. They’re not just moving out of their parents’ homes, where they’ve been holed up for years because they can’t afford the soaring rents or home prices, but now they’re also going to splurge on a set of wheels. Because it’s a great time to buy.
Interest rates for six-year new-car loans are as low as 2.75%, according to Bankrate.com. Loan terms can be stretched to seven years, to where these younger buyers will be awfully close to middle-age before they finally get out from under it. Loan-to-Value ratios have soared well past 100%; everything can be plowed into the loan: title, taxes, license fees, cash-back, and the amount buyers are upside-down in their trade. The package is governed by loosey-goosey lending standards. Bad credit, no problem.
And that’s exactly the problem.
Over 8.4% of subprime auto loans taken out in the first quarter of 2014 were already delinquent by November, according to an analysis of Equifax data by Moody’s Analytics for the Wall Street Journal. That’s the highest rate of early subprime delinquencies since Financial-Crisis year 2008.
Stuffing people into cars they can’t afford and ultimately may not be able to pay for is big business. Auto loans to subprime borrowers (credit scores below 640) make up over 31% of all auto loans, according to Equifax. Outstanding loan balances have soared nearly 17% over the last two years. At this rate, they’ll breach the $1-trillion mark by the end of the first quarter this year.
In broader terms, 2.6% of the auto loans taken out in Q1 2014 were delinquent by November, the highest rate of early delinquencies since crisis-year 2008, when they rose above 3%.
The bailed-out former auto lending unit of bailed out GM, Ally Financial, now the largest non-captive auto lender, reported $355 million in nonperforming auto loans in Q3 2014, up 8% from a year earlier. And during the first three quarters, it charged off as uncollectible $341 million, up 18% from the prior year.
Santander, one of the top 15 auto lenders in the US, discovered that it’s overall auto-loan delinquency rate in Q3 was a vertigo-inducing 16.7%, highest in the nation, followed by Capital One’s delinquency rate of 6.6%.
But there’s nothing to worry about.
“Auto loans continue to perform well, as they did during the recession,” explained Bill Himpler, Executive VP of the American Financial Services Association, a lobbying organization for the consumer credit industry, including auto lenders. “Concerns about a spike in delinquencies have not been substantiated by evidence,” he said to mollify our concerns, echoing Equifax’s soothing statement in October that “a bubble is not occurring” in subprime auto lending.
Regulators beg to differ.
“We’re putting banks on notice that we have concerns,” Darrin Benhart, deputy comptroller of supervision risk management for the Office of Comptroller of Currency, told the Wall Street Journal. They’re worried about the lackadaisical lending standards and extended loan terms, and about the high interest rates for subprime borrowers who don’t have other options. “It’s definitely an area that warrants some attention,” he said.
The subprime lending tactics of Ally, GM’s new captive lender GM Financial, and Santander have come under investigation by the Justice Department last year. And even as some of the bigger lenders are trying to be a little less aggressive with subprime loans, smaller lenders are jumping into the fray.
“Subprime delinquencies and losses are beginning to grow at a more rapid pace than we’ve seen in a long time,” said Kevin Duignan, global head of securitization for Fitch Ratings.
Lenders are on the hook for nearly $1 trillion in auto loans. A good part is subprime, and if the subprime bubble blows up, losses will hit these banks, and they’ll bleed, and their stocks will swoon, but it won’t take down the megabanks. The amounts aren’t big enough. A specialized lender or two might sink, and nerves on Wall Street would get rattled until a member of the FOMC tells Bloomberg TV that QE4 might be a possibility, which will jar stocks back into rally mode. But it won’t bring down the financial system.
Lenders, while licking their wounds, will tighten lending standards and shorten terms, and they’ll keep an eye on LTV ratios and credit scores. With shorter terms, payments jump. And with limits on LTV ratios, people who’re upside-down in their trade, have no cash, and want title, taxes, and license fees rolled into the deal, have trouble financing a new car.
These aren’t just a few individual cases, but much of the hollowed-out, over-indebted, underpaid middle class, the new American proletariat, the 62% of the population that has no emergency savings to cover a $500 car repair or medical bill. These households face, as the Federal Reserve said last year, “large-scale financial strain.” They’ve been bypassed by the Fed’s “wealth effect.” And with tighter lending standards, many of these folks won’t be able to buy a new car.
Auto sales have been a big force in boosting retail sales, consumer spending, manufacturing, transportation (trucking, railroads), and service activity. So when the auto subprime bubble pops, it won’t take down the financial system; but it will hit the broader economy.
Let’s hope – knowing that hope is not a strategy – that it doesn’t pop in synch with another debt-fueled economic miracle, now imploding, the shale oil and gas boom. Because that would knock down in one fell swoop the two major growth industries that have largely been responsible for whatever “recovery” we’ve had in the US.