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Is The Subprime Bubble About to Pop?
Appeared August 2014 - volume 11 - issue 8 - page 20
Article has been viewed 295 times.
There seems to have been a rebirth in auto sales over the past few years. The headlines say it all: “Used car market expected to roll in 2014” and “Forecast Strong for Used Car Sales Through 2020.” Cue the ticker-tape parade and big-band swing because Happy Days are Here Again! Right?
Customers are coming into dealerships today looking to buy cars, but most of them do not have the cash to pay in full. As a result, the credit spigot has been turned back on and it is flowing with financing for nearly all segments, especially the deep sub-prime. It’s the scenario everyone has been praying for over the past five years. It’s finally here, ready to be ceased.
While this is all good and welcomed news (who would ever say that increased sales were bad?), smart dealers know to not get too excited, yet. If the last half a decade has taught the industry anything, it is not to count your chickens before they’re hatched, or rather, don’t bank on your customer’s payments until the checks are cashed. Current trends in the auto financing world may be suggesting that the cycle has finally hit an upswing, but they might also be warning that what goes up must come down.
Anatomy of a Bubble
When a child suds up a bubble wand for the first time, purses his lips and blows he witnesses something really amazing. He sees a magical, iridescent, lighter than air, bundle of bliss that causes such delight and wonder. The second attempt brings just as much enjoyment and satisfaction as it drifts off into the air and out-of-sight. After a few minutes, the initial euphoria starts to wane and he has to amp up the excitement. He starts slowly, adding air a little at a time until it gets bigger, and bigger. Confidence builds and he continues to blow. There’s a blatant confidence developing and he believes that the more air he puts in, the bigger the bubble will get. His excitement makes him completely oblivious to the fragility of this scientific wonder and when it finally pops, he is in tears, confused and not sure what to do next. Sound familiar?
Just like the kid trying to blow the biggest bubble, pre-recession banks and mortgage companies were financing loans faster than the hammers could nail or the realtors could write the contracts. Values skyrocketed to unbelievable levels. Homeowner’s were cashing in on their new-found equity like they had hit the lottery. People were living the high-life without consideration that the bottom would ever drop. But it did, and it was devastating.
Looking for a Sign
It has been over five years since the loose-lending mortgage industry’s house of cards came crashing down and this country’s long, slow recovery started. Some would argue that it’s still not over, but every quarter the flatlining economy seems to be willed back into a pulse. The auto industry has suffered greatly during the Great Recession. Cars became scarce, and so did customers. Lenders left the scene and took away the capital. Dealerships either closed or adapted.
For the survivors, the used car landscape has changed a lot. Dealers, and lenders, have had to do what they have to do to stay in business. Longer payment terms. Looser credit standards. Rising vehicle costs. It might be risky, but this is what the new normal for the auto sales industry looks like.
According to Experian Automotive, the majority of used car loans on the books today have terms between 61 to 72 months, reaching 38.5 percent in 2014. That makes a five-year loan now the standard. Loans with terms between 25 to 36 months are the smallest percentage at 7.1 percent. What might be the most noteworthy of the Experian statistics is that the greatest percentage of change was in the 73 to 84 month term category, growing over 25 percent from this time last year.
“Longer-term loans continue to dominate the market,” Experian Automotive Senior Director Melinda Zabritski said.
In addition to longer terms, it looks as if lenders are having to go deeper as well. Larger percentages of loans are being issued to borrowers in the sub-prime credit score range. As deep subprime (<550) loans have increased 21 percent over last year, super prime loans decrease by six percent, according to Experian.
Another factor to add in the mix is the average amount being financed. Inventory shortages and market demands have driven used car prices to higher numbers. The average amount financed for a used car in the first quarter of 2014 was $17,927 according to Experian, a $395 increase over the past year.
Who’s Blowing the Bubble?
Most dealers remember how credit markets froze up in 2008, causing sales to plummet and dealers scrambling to get customers financing. Even if there was a customer ready to buy there were no lenders able to lend.
As part of the strategy to stabilize a downward-spiraling economy, the US Federal Reserve created a program called the Term Asset-Backed Securities Loan Facility (TALF). Under TALF, the Federal Reserve Bank of New York lent up to $1 trillion to holders of top-rated ABS loans (which included student loans, auto loans, credit card loans and SBA loans) and re-opened the market for auto loans. Auto financing started with prime credit borrowers but eventually, by 2011, had trickled down the FICO scale and subprime auto lending started to pick-up again. It’s been hot ever since.
A recent Standard & Poor’s report commented that rated subprime auto loan ABS issuance through June 30, 2014 reached $11.4 billion, up 15 percent from the first half of 2013. Today’s field is comprised of both large and small firms, as well as veterans (like Security National Automotive Acceptance Co., LLC and Byrider Finance) and first-time issuers and newbies (e.g. Exeter Finance Corp. and Flagship Credit Acceptance LLC).
“Wall Street is virtually throwing money at lenders, who are enthusiastically offering that money to dealers,” says a quote from Manheim’s 2014 Used Car Market Report. “Will lenders and dealers push this credit cycle too far and start making silly loans? Absolutey! But the bubble hasn’t been reached yet; might as well make the most of it while it lasts.”
When Will It Pop?
There is no need to hit the panic button yet, but there are indicators that it may be time to start planning for a less-than-great future. The Standard & Poor’s report says credit metrics in recently issued 2013 and year-to-date 2014 subprime retail auto loan ABS are deteriorating, raising questions about whether the subprime auto loan sector has overheated.
Fueling the concern are increases in payments 61 days or more delinquent in securitized subprime auto loan ABS rated by Standard & Poor’s, rising 37 percent in May. The report also cited static pool cumulative net losses that are trending higher as lenders continue to ease their credit standards and return to their historical lending activities.
The improving economy could also put added pressure on the subprime market. S&P says that some lenders have been growing rapidly and it remains to be seen if they are originating and collecting loans with adequate discipline and controls in place. Some lenders have also been observed lowering dealer discounts and raising allowable LTVs, which are tell-tale signs of increasing competition as they fight for dealer business.
Putting it in Perspective
Though it is large, the size of the subprime auto loan market is a tiny fraction of what the subprime mortgage market was in the boom before the bust, so even if a Doomsday, worst-case-scenario were to happen for most people the aftermath would not be as great. A repossession doesn’t bring down the values of the other cars in the lot and force families in the streets like a foreclosure can, but it can pose a black-eye to the dealer who was counting on the payment. As always, the dealers who pay attention, have a plan in place and position themselves for opportunity will be the ones to prosper, whether the bubble pops or not.
State of the Automotive Finance Market First Quarter 2014, Experian Automotive
2014 Used Car Market Report, Manheim
As Subprime Auto Lending Heats Up, ABS Transactions Remain Adequately Protected Against Increasing Credit Risk, Standard & Poor’s