A recent report by the New York Federal Reserve reveals that banks have tightened their lending requirements on subprime auto loans causing a steep decline in loan originations to consumers with less than good credit. A sharp increase in loans payments that are 90 days or more delinquent is thought to be behind the actions which, after several years of record subprime loan originations, is leading some market observers to talk about another financial bubble.
How Did We Get Here?
During the financial crisis, as home mortgage volume fell dramatically, banks turned to auto loans to make up for the lost revenue. The banks loosened their credit requirements and pitched low cost loans to consumers with subprime credit. For the next seven years auto loan volume skyrocketed, reaching a record level of $1.1 trillion in early 2017. At their height, loans to subprime borrowers accounted for nearly 25 percent of outstanding auto loans, or roughly $275 billion. According to the New York Fed, that figure fell to 21.8 percent as of the second quarter of 2017. Since 2009, that is just the second time subprime auto loan origination fell from the prior year.
Meanwhile, 90-day delinquencies, which are loans that are likely to be written off, have increased for the last three years, most recently rising to 3.92 percent of the total outstanding loans from 3.46 percent. According to the New York Fed Report more than 6 million Americans now hold auto loan debt that is 90 days or more delinquent, sparking concerns over a new crisis with bubble implications. Adding to the problem for lenders is the rapid decline in used car values, meaning lenders are recovering less on repossessed cars. Lenders are only recovering an average 51 percent of unpaid loan balances in 2017 as compared to 65 percent for 2011 auto loans.
Consumers’ Eyes are Bigger Than Their Wallet
One explanation for the increase in delinquencies is that subprime buyers are simply buying more car than they can afford. To keep their monthly payments lower they are financing their cars over a longer period of time. According to Experian, the average loan amount for new cars is $30,621 which is a new record. Used car loans average $19,329. While car prices have risen, wages for middle-income earners have stayed flat, forcing them to stretch out the loan terms on higher priced cars instead of opting for lower priced cars. Loans with terms of 73 to 84 months now account for 32.1 percent of new car loans, up from 29 percent a year earlier. 84-month loan terms for cars that start depreciating the moment they’re driven off the lot can’t be good for lenders or borrowers.
Banks Can’t Afford Another Crisis
Following their experience with the mortgage crisis, banks can no longer accept the risks of lending to subprime borrowers. But, many have also reigned in their lending to prime borrowers. Some banks are reevaluating their lending positions and looking at reducing their loan portfolios. As a result, car sales have been hit hard in 2017. Industry experts see the sales decline continuing for the next few years. The fear is that car companies with captive lenders might loosen lending requirements again to boost sales.
For the last seven years car loans have outpaced nearly all lending categories; but with fewer loan options and the prospect of higher interest rates, subprime borrowers will continue to avoid new car purchases. Less available credit will reduce the demand for cars and drive car sales down further. Until lenders can get ahead of the delinquencies their balance sheets will be challenged, so the only thing they can do is reduce their exposure to auto loans. All of this is happening at a time of low unemployment and low interest rates. Yet some consumers are just as strapped as they were in 2008 with record high credit card debt, student loan debt, and auto loan debt. There will be no bailouts this time for the lenders, so it may take several years for this cycle of bad debt to cleanse itself.