Loan losses have forced banks and private equity sources to shut down funding for an increasing number of smaller subprime vehicle lenders. That lack of funding is causing those subprime vehicle lenders to close up shop, according to Bloomberg.
Three subprime auto lenders that have filed for bankruptcy or shut down in recent weeks include Summit Financial Corp., Spring Tree Lending, and Pelican Auto Finance.
What Went Wrong for Those Subprime Auto Lenders?
Pelican Auto Finance, one of the private equity-sourced auto lenders, experienced trouble because of shrinking profits. That business handled deep subprime loans.
Summit Financial Corp. filed for bankruptcy last month. The company, based in Florida, had allegedly been misreporting its losses from loans, according to lenders such as Bank of America Corp., Bloomberg reported.
Spring Tree Lending was accused of fraud by investors. As a result, a creditor reportedly filed to force the lender into bankruptcy.
What Is a Subprime Loan?
Although it can vary a bit, subprime borrowers generally have a credit score that is under 600 to 640. There are several reasons that lead to lower credit scores.
One reason is the borrower hasn’t handled their accounts wisely in the past, and they have delinquencies and late payments on their record. Other borrowers haven’t necessarily been irresponsible with their money, but they don’t have much credit activity at all.
Because the risk is higher for lending companies to take a chance on subprime borrowers, they are charged higher interest rates for the privilege of getting a loan.
What These Closings Mean for the Economy
Some experts are comparing the heavy hits the subprime auto lending companies have taken in the automobile sector to the subprime mortgage crisis of 2007 to 2010. That crisis helped throw the country into a recession. The closing of subprime mortgage finance companies signaled larger losses to come.
As experts wait to see how this subprime auto lender situation plays out, some are worried more losses are imminent.
“There’s been a lot of generosity and not a lot of discretion on the part of lenders and investors,” Chris Gillock, a Colonnade Advisors banker, told Bloomberg.
But the silver lining, according to some experts, is that the subprime auto lending hiccup shouldn’t send the economy into a tailspin. Compared to the mortgage industry, the subprime auto loan industry is a much smaller sector.
At the close of September 2017, approximately $280 billion was outstanding in subprime vehicle loans. That pales in comparison to the $1.3 trillion in outstanding subprime mortgages in early 2007.
Why Have These Losses Happened?
The blame belongs partially to loose lending. By lending to risky borrowers, the companies are assuming larger amounts of risk that can lead to financial problems if the borrowers default on their loans.
At the end of September 2017, for instance, when looking at its riskiest borrowers, the auto loan companies were experiencing late payments overdue by at least 90 days on 9.7 percent of its loans to that category of borrowers. It’s the highest percentage of such late payments for auto loans since 2010.
As a result, consumers with poor credit have been finding it tougher to get auto financing. This has led to fewer subprime borrowers buying new cars this year.