Much has been made about whether a "bubble" exists in the auto lending market. Commentators define a bubble differently. Whatever we call it, recognizing the proliferation of troubling practices that mirror the precrash mortgage market is important because these practices deserve attention now.
According to Experian, outstanding auto loans in the fourth quarter of 2014 reached $886 billion, a record. While the overall share of subprime loans has remained steady, the expansion of the market means the number of subprime loans has increased significantly. The Federal Reserve Bank of New York stated in a recent report that "the dollar value of originations to people with credit scores below 660 has roughly doubled since 2009, while originations for the other credit score groups increased by only about half." Troublingly, the New York Fed also reported that in the second half of last year auto loan delinquency rates surpassed those for mortgage loans for the first time since the financial crisis. Auto loans and student loans were the only loan categories to see delinquency rate increases.
Some in the industry argue that auto delinquency rates are lower than in the mortgage market before and during the mortgage meltdown, but the speed of repossessions (48 days, per CNW Research) vs. foreclosures (577 days, per RealtyTrac) distorts the data. If it took as long to repossess a car as it takes to foreclose on a house the repossession rate would be 7.4 percent, 12 times higher than the 0.62 percent Experian reports.
The climb in delinquency rates coincides with a period of deteriorating underwriting standards. Experian data show that 60-plus month loans are the fastest growing category. In the fourth quarter of 2014, 73- to 84-month terms rose 19 percent for used vehicles and 29 percent for new vehicles. Longer loan terms may make the monthly payment seem affordable, but they increase the risk that the loan will outlive the car's usefulness to the owner.
Meanwhile, the average loan-to-value, or LTV, ratio for subprime loans stood at 125 percent at the end of 2013, according to Experian. This points to the importance of the F&I office to dealers. One of the main profit drivers for dealerships is the F&I office, so the sale of ancillary products is important. Financing those products requires higher LTVs.
Also, there are more transactions with negative equity. According to J.D. Power data, the percentage of cars financed that included negative equity rose 19 percent between 2009 and 2014. A J.D. Power spokesman told the Chicago Tribune that the average amount of negative equity financed in 2011 was more than $3,000, a record high.
One of the hallmarks of the mortgage meltdown was excessive risk-layering, that is, one risky practice was layered upon another. High LTV ratios, longer loan terms and negative equity all can be found in the same auto loan.
We all want a sustainable and fair market, but we can't ignore the data before us. Abusive lending practices, such as dealer interest markup, should be eliminated, and we should ensure that loans are not made unless the borrower's ability to repay is fully taken into account. Otherwise we risk creating needless economic harm.
You may email Chris Kukla at [email protected]