Thanks to the Fed's ZIRP, the investing world is on a constant reach for yield; and due to the fact that the last bubble of investor largesse (ignoring leverage and reality) was not 'punished' but in fact 'bailed-out', participants in the financial markets learned nothing. Just as the last crisis was formed on the back of an insatiable mortgage-backed security market desperate for new loans (any loans) of increasingly dubious quality to securitize, so this time it is subprime auto loans that have taken over. As a Reuters review [24] of court records shows, subprime auto lenders are showing up in a lot of personal bankruptcy filings. At car dealers across the United States, loans to subprime borrowers are surging - up 18% in 2012 YoY, to 6.6 million borrowers. Subprime auto lending is just one of several mini-bubbles the bond-buying program has created across a range of assets; "it's the same sort of thing we saw in 2007, people get driven to do riskier and riskier things." Of course, with auto production having been the backbone of so many macro data points that are used to 'show' the real economy recovering (despite the channel-stuffing [25]), now that the growth in auto-sales are stalling [26], it is for the subprime originators "under extreme pressure to hit goals" in their boiler-room-like dealings to extend loans (at ever higher rates) and securitize while the Fed 'music' is still playing. It seems we truly never learn.
Via Reuters, [24]
How The Fed Fueled An Explosion In Subprime Auto Loans
Thanks largely to the U.S. Federal Reserve, Jeffrey Nelson was able to put up a shotgun as down payment on a car.
Money was tight last year for the school-bus driver and neighborhood constable in Jasper, Alabama, a beaten-down town of 14,000 people. One car had already been repossessed. Medical bills were piling up.
And still, though Nelson's credit history was an unhappy one, local car dealer Maloy Chrysler Dodge Jeep had no problem arranging a $10,294 loan from Wall Street-backed subprime lender Exeter Finance Corp so Nelson and his wife could buy a charcoal gray 2007 Suzuki Grand Vitara.
All the Nelsons had to do was cover the $1,000 down payment. For most of that amount, Maloy accepted Jeffrey's 12-gauge Mossberg & Sons shotgun, valued at about $700 online.
In the ensuing months, Nelson and his wife divorced, he moved into a mobile home, and, unable to cover mounting debts, he filed for personal bankruptcy. His ex-wife, who assumed responsibility for the $324-a-month car payment, said she will probably file for bankruptcy in a couple of months.
When they got the Exeter loan, Jeffrey, 44 years old, was happy "someone took a chance on us." Now, he sees it as a contributor to his financial downfall. "Was it feasible? No," he said.
...
At car dealers across the United States, loans to subprime borrowers like Nelson are surging - up 18 percent in 2012 from a year earlier, to 6.6 million borrowers, according to credit-reporting agency Equifax Inc. And as a Reuters review of court records shows, subprime auto lenders are showing up in a lot of personal bankruptcy filings, too.
It's the Federal Reserve that's made it all possible.
...
The Fed's program, while aimed at bolstering the U.S. housing and labor markets, has also steered billions of dollars into riskier, more speculative corners of the economy. That's because, with low interest rates pinching yields on their traditional investments, insurance companies, hedge funds and other institutional investors hunger for riskier, higher-yielding securities - bonds backed by subprime auto loans, for instance.
...
Lenders like Exeter have rushed to meet that demand. Backed by Wall Street banks and big private-equity firms, they have been selling ever-greater amounts of subprime auto loans in the form of relatively high-yield securities and using the proceeds to fund even more lending to more subprime borrowers.
...
Consider that in 2012, lenders sold $18.5 billion in securities backed by subprime auto loans, compared with $11.75 billion in 2011, according to ratings firm Standard & Poor's. The pace has continued so far this year, with $5.7 billion of the securities issued, compared with $4.4 billion for the same period last year, according to Deutsche Bank AG. On Monday alone, three deals totaling $1.6 billion of subprime auto securities were announced by Wall Street banks.
To make up for the risk of taking on increasing numbers of high-risk borrowers, subprime auto lenders charge annual interest rates that can top 20 percent.
The Exeter loan Nelson and his wife got, for example, carried a 21.95-percent rate.
...
Critics of the Fed say the growth in subprime auto lending is just one of several mini-bubbles the bond-buying program has created across a range of assets - junk bonds, subprime mortgage securities, and others.
...
"It's the same sort of thing we saw in 2007," said William White, a former economist at the Bank for International Settlements. "People get driven to do riskier and riskier things."
...
"We are sailing deeper into uncharted waters," Fisher said in a speech six days after the Fed's September 13 announcement of QE3. "Why would the Fed provision to shovel billions in additional liquidity into the economy's boiler when so much is presently lying fallow?"
...
Subprime auto loans may seem like an obscure corner of finance, but the names behind the expansion are familiar.
Santander Consumer USA Inc, a unit of giant Spanish bank Banco Santander SA, is one of the biggest sellers of securities backed by subprime auto loans, according to S&P. In 2011, KKR & Co, Warburg Pincus and Centerbridge Partners bought a 25 percent stake in the Santander unit for $1 billion.
Capital One Financial Corp, General Motors Co and Ally Financial Inc are also steadily increasing loans to subprime borrowers.
...
Less well-known upstart Exeter, founded in 2006 and based in Irving, Texas, is run by executives from AmeriCredit Corp, an auto-finance company acquired by General Motors in 2010. It reported $100 million in originations in May 2010. It expected to hit $1 billion in 2012 and $2.2 billion by 2015
...
In 2008, a Goldman Sachs Group Inc fund, through an investment in a private-equity fund, helped infuse money into Exeter. Then, in 2011, Blackstone bought its controlling stake
...
After the Blackstone deal, in particular, the push was on for Exeter to expand its loan book, according to a former employee. "Everybody was under extreme pressure to hit goals," this person said. "Your job is in jeopardy. It was not sugar-coated."
...
Exeter touts the firm's "highly sophisticated risk management process," which employs a "decision science" system underpinned by "predictive models." The marketing book adds: "The end result is to deploy tools to management allowing for precision control over credit performance."
...
This process results in customers with an average credit score of 556 and average annual income of $38,393, according to the pitch book. These borrowers pay an average interest rate of 21.4 percent a year.
...
Moody's Investors Service, in a move rare among ratings agencies, issued a report in March 2012 saying it would not have assigned a high investment-grade rating to the notes. "Exeter is small and unrated, with limited experience and little asset performance history," it said.
...
Regardless of the relative safety of such securities, a rapidly growing lending business that bakes into its assumptions a 25 percent failure rate is almost certain to result in more people defaulting on more loans. In 2011, Exeter Finance was listed as a creditor or participant in 252 bankruptcy proceedings. In 2012, the number increased to 1,144.
...
...bulk of the filings he works on involve subprime debt - loans his clients shouldn't have gotten in the first place. "Most of them that's getting those types of loans are the same ones who's getting the cash loans or payday loans or title loans," Wadsworth said.
Charles Thomas, an electrician in Park Forest, Illinois, filed for Chapter 7 bankruptcy only four months before he took out loans from Exeter and Santander in November 2011.
Efforts to buy a car failed at six different dealers, but an online car-loan application he had filled out prompted an employee from Family Hyundai to call: Thomas had been preapproved... (Thomas's bankruptcy court filing lists personal property of $25 in a checking account, $1,000 in household goods and $300 in clothing).
...
Despite the risk that borrowers like Thomas present, investors have proved increasingly willing to put their money into subprime auto debt for lower relative returns. According to Barclays Plc, the average spread - a measure of investors' risk tolerance - between top-rated securities underpinned by prime and subprime auto loans and a benchmark interest rate hit 0.32 percentage point in February. That represents a remarkable increase in risk appetite from the 8.85-percentage-point spread at the peak of the financial crisis in autumn 2008.
...
With so much investor money backing subprime auto loans, and the resulting expansion of lending to questionable borrowers, some market watchers are beginning to sound alarms - albeit muted ones. Fitch Ratings in March said it was "concerned that the competitive landscape is creating an environment that encourages lenders to compete by easing credit terms."