US sub-prime auto loans breach $1 trillion as lenders lower credit standards and inflate the bubble
In the auto loan market both delinquencies and the total amount of outstanding auto debt continue to rise. With the total debt now breaching $1 Trillion and CNBC causing a stir last week when it dedicated airtime to suggesting people take out a seven year car loan we are increasingly reading about the subprime auto bubble peaking. Last week Goldman added its voice to the concerns saying that the risking inherent in the subprime market are materializing and that at the margin, growth has been created by lowering credit standard and extending terms to a whole load of “new” auto buyers.Zero Hedge 5-Mar-15Talk Markets 8-Mar-15
We’ve written extensively of late about the parallels between today’s subprime auto lending market and the conditions that prevailed in the subprime housing market on the eve of the collapse. Essentially the dynamic is the same. Lending to underqualified borrowers proliferates, leading to a large pool of securitizable loans. Issuance of ABS based on those loans rises as IBs see an opportunity to take advantage of investors’ hunt for yield. Rising demand for subprime ABS fuels demand for more subprime loans to securitize, prompting lenders to relax their standards in an effort to make eligible borrowers out of ineligible borrowers. New loans begin to carry longer terms (in order to lure buyers who need low monthly payments), lower FICO scores, and are often made for more than the total cost of the asset. Delinquencies rise. Cue collapse.

As we’ve shown, delinquencies are indeed rising as is the total amount of outstanding auto debt, the latter having touched a massive $1 trillion, putting auto loans in position to join student debt in full-on bubble mode. Our fears were confirmed last week when, in the surest sign yet that the subprime auto bubble has reached its peak, CNBC unveiled what we have dubbed the “car-stock arbitrage,” wherein viewers are advised to take out an 84 month car loan and dump the money into the stock market at all time highs.

Meanwhile, GMAC disclosed an SEC probe into subprime ABS origination and the higher ups at Wells Fargo (WFC) (perhaps after someone in the research department suggested that a 60% Y/Y increase in banks’ tendencyto originate loans for the purpose of selling them might be a red flag) suddenly got cold feet last month after financing $30 billion in car loans in 2014 and decided to put a cap on subprime auto lending.

Given all of that, we were shocked — shocked — when February auto sales turned out to be a BNSF-style trainwreck (even AutoNation CEO Mike Jackson’s “trucks, trucks, trucks” couldn’t save the day as Ford F-Series (F) sales fell 1.2%). Of course to let the media tell it, February’s disastrous numbers were due to weather (snow in the winter) but we had our doubts and so were not surprised when a new note from Goldman confirmed, by way of an avalanche of data and charts, precisely what we’ve been saying all along which is that the risks inherent in subprime lending are materializing and that at the margin, growth has all been created by lowering credit standards and extending terms to a whole load of 'new' auto buyers.

From Goldman:

Subprime loans accounted for 21% of US new vehicle sales in January 2015, trending above the pre GFC level of just over 16% for seven consecutive months since June 2014. We attribute the ongoing strength in subprime to (1) pent-up demand by subprime borrowers as lenders pulled back significantly from subprime auto lending during the recession and 1-2 years afterwards, and (2) the low interest rate environment, which has made subprime loans more attractive for investors chasing yield. On the latter, the management team for Santander Consumer (SC), the largest subprime auto lender in the US, noted that the resulting liquidity (particularly the ease of funding through ABS or wholesale bank lines of credit) has enabled smaller, nonbanks to grow faster and become more aggressive with lending. On the demand side, low interest rates have enabled subprime borrowers to afford more expensive vehicles, which we believe has contributed to the outsized growth in new subprime car sales vs. used. A breakdown of loan value by FICO score, released quarterly by the Federal Reserve Bank of New York, shows an increase in loans to borrowers with FICO scores below 620.

Subprime loan to sales ratio is at record highs…

… while the number of loans made to underqualified borrowers is rising…

… and nearly two thirds of loans made by the market’s largest lender type are subprime ....

…while the second and third largest players in the market are seeing the highest loss and delinquency ratios since the crises…

…and here’s Goldman on the shifting regulatory environment:

Although the CFPB is not explicitly looking to tighten credit standards or reduce demand for subprime borrowers, its intent of increasing monitoring of large non-bank auto lenders and discriminatory practices may have an impact on subprime originations. On September 17, 2014, the CFPB proposed amending regulation to define “large participants” in the auto lending market and include non-bank lenders, which would include captive finance and other companies that make, acquire, or finance 10,000 or more auto loans or leases per year. The CFPB has estimated that about 38 new finance companies would be impacted. In addition, the CFPB has explicitly expressed concerns on discriminatory lending practices in the form of charging different mark up to different borrowers and has suggested the possibility of imposing a lower markup cap of 100bp rather than the more common limits of 200bp or 250bp. While these are not surprising to us given that non-banks account for roughly 65% of auto loan originations, increased regulation could lead to higher compliance costs and the reduced mark-up cap could pressure revenues of subprime focused dealers as markups tend to be higher on subprime loans.

As one might expect, US automakers are the most exposed to subprime, with GM, Chrysler, and Ford accounting for 50% of the US subprime market (GM and Chrysler also sport the industry’s highest percentage of subprime to total sales)...

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In the end, Goldman comes to exactly the same conclusion as we did months ago, namely that despite the financial media’s parroting about snow in the winter, the simple fact is that as soaring delinquencies and government probes conspire to cut the least-creditworthy Americans off from debt servitude, bad things will happen in US car sales: