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Auto Sales and Loans at Record Highs: Is a Bubble Looming?

November 16, 2016
Crushed cars: Will the surge in subprime auto loans create another financial bubble?

The auto industry has been propelled into record sales territory thanks to slow but solid economic growth, the post-recovery pent-up demand for new cars, and new technology enticing drivers.

And then there are the extended loan periods that allow consumers, some of them in that murky range called “subprime,” to take on bigger debt loads with smaller monthly payments for longer periods of time. Some extend to seven years.

Will auto loans be the next sector to blow up and threaten the economy in similar fashion to the mortgage crisis a few years back? Should we worry?

The short answer is no. Subprime auto lending represents just a smidgen of outstanding debt compared to the subprime home mortgages that led to the last financial crisis, according to Experian, the credit-reporting bureau. But, yes, there are analysts, and even top bank executives, who worry that the easy credit—and “easy” is a relative term in post-recession nomenclatures—extended to some portions of the borrowing population may be problematic.

At an auto analyst conference in June, JPMorgan Chase CEO Jamie Dimon called the auto industry “clearly stretched,” and forecast higher losses ahead for his competitors. “Someone will get hurt in auto lending,” he said. “It won’t be us.”

Auto Industry Revs Up  

As the economy recovered post-crisis, U.S. consumers sped into car dealers in record numbers as cheap gasoline and higher employment helped relieve the pent-up demand that had built up during the recession. Thus, auto industry sales hit a record peak last year of 17.5 million new vehicles, after six straight years of rising growth.

In the first quarter of 2016, sales were still booming, but the second quarter has seen a single-digit falloff from the same period in 2015. Still, sales are ringing up strongly on a historical basis, although the auto industry may need to juice them going forward with better incentives and deals to keep the pace robust, analysts said.

Car-loan balances topped $1 trillion for the first time ever in the first quarter of the year. As of the end of the second quarter, those liabilities sat at $1.027 trillion, a 10% jump over the same period a year ago, according to Experian’s quarterly report on the auto industry.

Subprime loans grew as lenders loosened requirements, allowing more lower-quality credit borrowers to get in on the action. What Experian refers to as “deep subprime” loans, given to consumers whose credit scores range from 300 to 500 on the firm’s 850-point range, jumped nearly 12% on a year-over-year basis at the end of the second quarter. Subprime loans, which are given to those with credit scores between 501 and 600, saw an 8% swing higher.

How did that balloon expand? With fatter loans, of course. The average advance for a new car rose to a new high of $29,880, Experian said, with used car loans now averaging $19,101. 

Remember, too, that subprime borrowers are hit with notably higher interest rates than their super-prime neighbors—sometimes as much as double—and, as a result, represent fatter profits to lenders, provided such borrowers remain current on their loans. And then there’s this: Subprime borrowers are not the only ones who end up in default. Plenty of prime borrowers do, too, but it may be easier to resell a repossessed car from a prime borrower than it is from a subprime nonpayer.

No matter who defaults, massive auto loan defaults could lead to an over-saturation in the used car market that might drive down the cost of all car models. That’s a potential economic woe, for sure, but not all finance executives are as worried as Jamie Dimon. Ally Financial CEO Jeff Brown takes the opposite view.

Auto loans are still his firm’s “bread and butter,” and Brown noted profitability will not disappear even if auto loan losses were to double. “We think some of the credit fears in auto are, candidly, a bit overdone,” Brown said at the same conference at which Dimon spoke. “While we have a pretty high concentration in the auto industry, both in sales and the credit exposure, we understand the industry better than anyone else. We’ve been in it for almost 100 years.”

But now auto lenders need to consider the driving future, which may or may not include the fledgling self-driving autos that will be on the market sooner than many consumers might think. Is that another auto bubble on the horizon? Time, and driving patterns, will tell.

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