US Subprime is Back – this Time it’s Auto Loans

It’s no great secret that global automakers are having a tough time, sales are falling leading to inventory building and furloughs or shutdowns of production facilities. In Australia car sales have fallen 8% this year, with weak consumer sentiment and tighter lending standards post the Royal Commission taking the blame. China’s auto sales have seen a similar drop, whilst the US is just slightly negative. Getting finance in the US isn’t currently an issue, if anything it is far too easy to get a loan to buy a car. 86% of new car sales in the US are financed so changes in the availability of finance will have a substantial impact on the volume of future car sales.

In US auto lending, borrowers are graded into two main loan categories, prime and subprime. There’s some shading between those two categories, but as a guide subprime borrowers will pay an average interest rate around three times higher than prime borrowers. For the prime segment, arrears are very low as would be expected when unemployment is low. 

For subprime loans it is another story altogether with the graph below from Wolfstreet.com showing that arrears for all loans are now as bad as they were during the financial crisis when unemployment was far higher. As prime loans make up 78% of all loans and with arrears less than 0.5%, it’s a surge in subprime arrears that is driving the average US arrears rate higher. Over 20% of US subprime auto loans are in arrears, when unemployment is close to all time lows. There’s only one explanation for that, subprime lending quality is abysmal.

A recent article from Mish Shedlock highlighted a few crazy stories, including one borrower who took out a $45,000 loan for a $27,000 car. The $18,000 gap comes from the negative equity position on the old loan that the new lender is funding. In recent years around one-third of all auto loans have involved borrowers rolling over negative equity from one loan to the next. Another trend has been to amortise loans over a longer period, making the repayments smaller so the borrower can afford a larger loan. That then feeds back into the negative equity problem as the car is worth less than what is owed for a far longer period.

If you are getting those feelings of déjà vu all over again, that’s because this looks a lot like US subprime home lending from 2004-2007. Just as almost anyone could get a home loan then, now almost any American can get an auto loan. There is one big difference though, outstanding US auto loans total $1.3 trillion, a small fraction of the $15.6 trillion of US mortgage debt outstanding. Whilst this sector won’t cause a financial crisis on its own, it’s just another sign of the bad behaviour encouraged by central banks printing money and setting interest rates far too low.