The dollar value of subprime auto loan originations has nearly doubled since 2009 to reach $20.6 billion, or 22.2% of total auto loan originations, in the second quarter of 2014, per the Quarterly Report on Household Debt and Credit for the quarter released by the Federal Reserve Bank of New York last week. While the proportion of subprime loans to total auto loans is significantly lower than 25–30% in the pre-recession period, it is still a concern due to the fact that auto loans rank third among loan groups, following mortgages and student loans, in terms of America’s outstanding debt.
Moreover, originations of subprime auto loans (loans to borrowers with credit scores below 620) are increasing at a faster pace compared to the rest of the auto loans. Originations of loans to the other credit score groups increased merely 50% since 2009. In fact, auto loan originations to the super-prime group (borrowers with credit scores above 759) increased only 43.1% to $27.9 billion in the second quarter of 2014 from $19.5 billion at the end of 2009.
A majority of the subprime auto loan originations can be attributed to auto finance companies. In fact, these companies issued three times the dollar value of subprime loans issued by banks during the second quarter of 2014. Needless to say, this is helping boost sales of the associated auto companies.
Easy availability of auto loans with lower interest rates and longer repayment periods is one of the chief reasons for the rising U.S. auto sales. Auto loan balances (including leases) have been increasing consistently in the past 13 quarters and auto loan originations in the second quarter of 2014 climbed to an eight-year high. Buoyed by this, U.S. auto sales on a seasonally adjusted annualized rate (SAAR) remained above the 16 million mark in the last 5 months. In fact, in Jun 2014, the SAAR of sales reached 17 million for the first time since Jul 2006.
As the automobile industry is a major contributor to the U.S. economic growth, improving auto sales is also benefiting the overall U.S. economy. However, concerns about the subprime auto loans are rising.
Recently, federal prosecutors started a civil investigation into the matter. They are concerned that auto loans are possibly being issued without adequate background checks and adherence to standards. They are also looking into possible violations of the Financial Institutions Reform, Recovery, and Enforcement Act.
Earlier this month, General Motors Co. (GM - Free Report) received a subpoena as a part of this investigation, requesting documents related to the origination and the securitization of subprime loan contracts since 2007. The United States attorney for the Southern District of New York will consider other auto companies as a part of the investigation as well, per media reports. Most major auto and truck manufacturers such as General Motors, Ford Motor Co. (F - Free Report) , Toyota Motor Corp. (TM - Free Report) , Honda Motor Co. Ltd. (HMC - Free Report) , PACCAR Inc. (PCAR - Free Report) and Tesla Motors Inc. (TSLA - Free Report) provide financing and leasing to customers.
Should We Be Worried?
While subprime auto loan originations are increasing rapidly, so are the total auto loan originations. Consequently, the proportion of subprime auto loan originations to total auto loan originations has not increased significantly. Moreover, the 90-day delinquency rates for auto loans is only 3.3%, on par with home equity lines of credit and lower than all the other loan groups as well as the average delinquency rate.
In fact, economists from the Federal Reserve Bank of New York believe that the increase in subprime auto loans is not extreme, given the rising auto sales. They also reason that since subprime auto loans witnessed the maximum decline during the recession, the present rise in this loan group is more pronounced than other groups.
Thus, the increasing subprime auto loans should not pose any abnormal risk unless their proportion to total auto loans starts increasing significantly or the civil investigation reveals any major negligence in conforming to loan standards.