Subprime Auto Loans Are Not The Next ‘Big Short’

Subprime Auto HeadlineThe auto industry is facing many different headwinds right now. The industry is incredibly cyclical and many people think that we have just seen peak auto sales which means auto manufacturers might struggle to sale cars over the next couple years. Over the last couple years auto manufacturers lowered lending standards to stimulate sales. Today, the average loan term for new cars is 68 months and it is 63 months for used. Both of these have never been higher. The average amount financed for a new vehicle is $28,802 which has never been higher. The average length of loan has been extended to help individuals have lower monthly payments but for a much longer period of time.

At the beginning of 2016, auto loan delinquencies creeped higher as a result of low oil prices. Americans were getting laid off from the oil and gas industry and consequently were not able to pay for their vehicles. This is no longer happening as often since oil prices have stabilized in the last few months. When auto loan delinquencies were on the rise, many people took it as an opportunity to scare people into thinking another bubble was about to pop. However, I do not believe this to be the case for many reasons. I think they will need to look elsewhere for the next big short.

The 2009 recession resulted in a major slowdown in auto sales. Only 9.3 million vehicles were sold in 2009. This created a lot of pent up demand which has worked its way out over the last seven years. Most Americans need financing to buy vehicles which has resulted in expansion of the auto loan market over this time period. This is a very normal occurrence, not any kind of bubble. Additionally, synthetic securities tied to auto loans do not exist and probably never will. Synthetic securities tied to mortgages were the primary reason for the financial crisis.

People have forgotten that vehicles and homes are completely different assets. The default process around vehicles is completely different from houses. Looking back at data from the housing crisis, it took 194 days to complete a foreclosure in Arizona; 335 days, or almost a year, in California; 520 days, or about 1 1/2 years, in Nevada; and 858 days, or almost 2 ½ years, in Florida. By way of comparison, in New York it takes 1,072 days to foreclose on a residence. As the foreclosure process goes on, most houses are abandoned resulting in plummeting values. Consequently, neighboring property values also decline. Today, when people default on their automobiles, they are repossessed almost immediately. The legal process is extremely fast so there is minimal value lost on repossessed vehicles. They can be resold quickly mitigating losses from the bad loans.

Another differentiating factor from the housing crisis comes from financial institutions. Lending risk models have been closely scrutinized since the financial crisis and are much improved. Even when defaults occur, losses are minimal because loan-to-value (LTV’s) are heavily scrutinized. Probability of default’s (PD) and loss given default’s (LGD) are updated more frequently and watched closely. No financial institution will be taking on large losses because lending models on subprime loans incorporate the risks the bank is taking. In the event that there is a default on a loan, the vehicle can be repossessed and resold minimizing loses. This process has almost no drag on the economy.

When financial institutions underwrite a subprime auto loan they often require the borrower to have their car equipped with a device that allows the lender to disable the car remotely. These devices include GPS technology so the lender can communicate the location of the vehicle if it needs to be repossessed. These devices make repossession incredibly fast.

In addition to the devices mentioned, there are hundreds of different license-plate-readers on the roads today. These are often found at airports, toll plazas, major highway entrances, parking garages, and selected intersections. Developing databases of scanned license plates is a growing business. Financial institutions are willing to pay to have access to this information.

Bottom Line

Subprime auto loans are completely different than subprime mortgages. There are glaring differences between the two products. The biggest difference between them is the amount of time it takes to repossess a vehicle versus foreclosing on a house. Repossessing a vehicle is quite easy and the asset can be resold in a timely fashion which keeps the lenders losses minimized.

Lending risk models are much improved on all loans since the financial crisis. Financial institutions are reviewing their loan files more often and are much more conservative than they were ten years ago. It is very possible that auto sales may slow down in the next 12 months. However, I do not see any similarities to the housing crisis and I would certainly not call the growth in subprime auto loans a “bubble.”




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