Perhaps more than anyone else, we’ve been keen on documenting the rise of subprime auto loans.
Over the course of the last 12 months, data from Experian clearly shows that underwriting standards are falling in the industry as competition for a shrinking pool of eligible borrowers heats up.
- Average loan term for new cars is now 67 months — a record.
- Average loan term for used cars is now 62 months — a record.
- Loans with terms from 74 to 84 months made up 30% of all new vehicle financing — a record.
- Loans with terms from 74 to 84 months made up 16% of all used vehicle financing — a record.
- The average amount financed for a new vehicle was $28,711 — a record.
- The average payment for new vehicles was $488 — a record.
- The percentage of all new vehicles financed accounted for by leases was 31.46% — a record.
Note that this is the same dynamic that unfolded in the US housing market in the lead up to the crisis. In order to keep the music going, the universe of borrowers must be perpetually expanded, and that means extending more generous terms to entice customers.
This is critical for two reasons. First, the much ballyhooed US auto “renaissance” must be sustained at all costs or else Phil LeBeau won’t have anything to talk about. As we demonstrated last week, the cracks are already starting to show.
Second, Wall Street’s securitization machine needs feeding. Just as securitizations fueled the housing market prior to the meltdown in 2008, so too does consumer ABS issuance “drive” (no pun intended) the auto market in America today. The model is called “originate to sell,” which simply means that lenders make loans and promptly sell them off for securitization by investment banks who then sell the resulting paper to investors. Obviously, this exacerbates the trend towards lower underwriting standards. That is, if the loan isn’t going to stay on my books, why do I care if the borrower is creditworthy?
Over the last year we’ve seen some truly awful deals go off including a number of horrendous securitizations from Skopos Financial, where “the best part [about getting a loan] is speed.” In late October, Skopos went “full-retard”, selling $154 million of paper backed by a pool of credits in which 14% of the loans were made to borrowers with no credit score.
Needless to say, news that those kind of deals are getting done might well spook investors who have managed to keep a level head amid what is now a trillion dollar bubble.
When investors get spooked, they want more yield for their trouble and that’s likely especially true now given the worrying statistics on loan terms and the three charts shown above.
Given all of this, we weren’t terribly surprised to learn that Deutsche Bank is now conducting an internal probe to determine whether employees “exaggerated demand” in the course of selling subprime ABS in an effort to artificially suppress yields.
“Deutsche Bank AG officials are reviewing whether some employees exaggerated demand as they marketed new securities backed by risky auto loans, potentially suppressing yields for investors,” Bloomberg reports, citing people familiar with the matter. “The bank has looked at communications between the employees and investors to determine whether such marketing practices were normal salesmanship or if they crossed a line, said the person, who asked not to be named because the matter is private.”
Apparently, new CEO John Cryan is also looking at whether special treatment was afforded to VIP clients.
So, it would appear that demand for auto loan ABS may be beginning to dry up as investment banks are forced to engineer an artificial buzz around new deals in order to keep skeptical investors from demanding sharply higher yields.
As a reminder, if the market for auto loan ABS stalls (so to speak), it will trigger a chain reaction all the way down to the dealers who will suddenly care about the creditworthiness of borrowers again.
Once that happens, the US auto "miracle" will suddenly disappear in a cloud of noxious tail pipe exhaust as the one reliable "driver" of consumption in America is exposed for what it is: a castle built on subprime quicksand.