It has been over six months since we first highlighted the growing deterioration in the quality of auto loans and mentioned the 's' word (subprime) as indicative that we learned nothing from the financial crisis. Since then, auto loans (and especially subprime in the last few months) have surged to record highs; and most concerning, recently has seen delinquencies and late payments spike. The reason we provide this background is that, thanks to The NY Times, this story is now hitting the mainstream media as subprime-quality car buyers (new and used) realize the burden they have placed on themselves thanks to exorbitantly high interest rates (and a rapidly depreciating 'asset'). As one car 'owner' exclaimed, "buying the car was the worst decision I have ever made."
As The NY Times reports, Auto loans to people with tarnished credit have risen more than 130 percent in the five years since the immediate aftermath of the financial crisis, with roughly one in four new auto loans last year going to borrowers considered subprime — people with credit scores at or below 640.
Deja vu all over again...
And, like subprime mortgages before the financial crisis, many subprime auto loans are bundled into complex bonds and sold as securities by banks to insurance companies, mutual funds and public pension funds — a process that creates ever-greater demand for loans.
Exorbitant interest rates... (but still demand?)
The New York Times examined more than 100 bankruptcy court cases, dozens of civil lawsuits against lenders and hundreds of loan documents and found that subprime auto loans can come with interest rates that can exceed 23 percent.
The loans were typically at least twice the size of the value of the used cars purchased, including dozens of battered vehicles with mechanical defects hidden from borrowers. Such loans can thrust already vulnerable borrowers further into debt, even propelling some into bankruptcy, according to the court records, as well as interviews with borrowers and lawyers in 19 states.
Will we never learn...?
In another echo of the mortgage boom, The Times investigation also found dozens of loans that included incorrect information about borrowers’ income and employment, leading people who had lost their jobs, were in bankruptcy or were living on Social Security to qualify for loans that they could never afford.
“It appears that investors have not learned the lessons of Lehman Brothers and continue to chase risky subprime-backed bonds,” said Mark T. Williams, a former bank examiner with the Federal Reserve.
One painful example...
Rodney Durham stopped working in 1991, declared bankruptcy and lives on Social Security. Nonetheless, Wells Fargo lent him $15,197 to buy a used Mitsubishi sedan.
“I am not sure how I got the loan,” Mr. Durham, age 60, said.
Mr. Durham’s application said that he made $35,000 as a technician at Lourdes Hospital in Binghamton, N.Y., according to a copy of the loan document. But he says he told the dealer he hadn’t worked at the hospital for more than three decades. Now, after months of Wells Fargo pressing him over missed payments, the bank has repossessed his car.
It's different this time...(worse)
Autos, of course, are very different than houses. While a foreclosure of a home can wend its way through the courts for years, a car can be quickly repossessed. And a growing number of lenders are using new technologies that can remotely disable the ignition of a car within minutes of the borrower missing a payment. Such technologies allow lenders to seize collateral and minimize losses without the cost of chasing down delinquent borrowers.
That ability to contain risk while charging fees and high interest rates has generated rich profits for the lenders and those who buy the debt. But it often comes at the expense of low-income Americans who are still trying to dig out from the depths of the recession, according to the interviews with legal aid lawyers and officials from the Federal Trade Commission
Who is to blame? Nefarious dealers?
The dealers have an incentive to increase both the size and the interest rate of the loans.
The arithmetic is simple. The bigger size and rate of the loan, the bigger the dealers’ profit, or so-called markup — the difference between the rate charged by the lenders and the one ultimately offered to the borrowers. Under federal law, dealers do not have to disclose the size of the markup.
Or The Fed's financial repression money printing forcing demand into these risky securities?
Investors, seeking a higher return when interest rates are low, recently flocked to buy a bond issue from Prestige Financial Services of Utah. Orders to invest in the $390 million debt deal were four times greater than the amount of available securities.
What is backing many of these securities? Auto loans made to people who have been in bankruptcy.
The average interest rate on loans bundled into Prestige’s latest offering, for example, is 18.6 percent, up slightly from a similar offering rolled out a year earlier. Since 2009, total auto loan securitizations have surged 150 percent, to $17.6 billion last year, though some estimates have put the total volume even higher.
In another sign of trouble ahead, repossessions, while still relatively low, increased nearly 78 percent to an estimated 388,000 cars in the first three months of the year from the same period a year earlier, according to the latest data provided by Experian.
The number of borrowers who are more than 60 days late on their car payments also jumped in 22 states during that period.
As a result, some rating agencies, even those that had blessed auto loan securitizations with high ratings, are starting to question the quality of the loans backing those securities, and warn of losses that investors could suffer if the bonds start to sour. Describing the potential trouble ahead, Kevin Cole, an analyst with Standard & Poor’s, said, “We believe these trends could lead to higher losses and weakened profitability in a few years.”
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One quick question... (rhetorical of course) - Why did the Federal Reserve stop reporting auto-loan LTVs in February 2011? After 40 years of doing so!!
Bloomberg has reported the average loan to value (LTV) for subprime auto loans has increased to 114.5% this year and the average loan-to-value on new cars rose to 110.6% (which would be the highest ever according the Fed's data... way beyond the 100.4% previous peak in Sep 2006)
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As we concluded previously, it is so bad that even Morgan Stanley now gets it:
“Perhaps more than any other factor, easing credit has been the key to the U.S. auto recovery,” Adam Jonas, a New York-based analyst with Morgan Stanley, wrote in a note to investors last month. The rise of subprime lending back to record levels, the lengthening of loan terms and increasing credit losses are some of factors that lead Jonas to say there are “serious warning signs” for automaker’s ability to maintain pricing discipline.
And who gets to eat the losses? Well, as we have previously explained, the bulk of consumer credit issuance in the past year, a massive 99%, has been sourced by the government to go straight into auto and student loans.
Which means you, dear US taxpayer, will once again be on the hook when the music ends.