From Wolf Richter at wolfstreet.com:
“Fears of an impending liquidity crunch in that asset class.”
“What is happening in this space today reminds me of what happened in mortgage-backed securities in the run-up to the crisis,” U.S. Comptroller of the Currency Thomas Curry warned in October about the auto loan bubble.
And his warning is now becoming reality.
Subprime auto loans aren’t big enough to take down our megabanks, the way subprime mortgages had done. But they’re big enough to take down specialized auto lenders and cause a lot of tears among investors that bought the highly rated structured securities backed by subprime and deep-subprime auto loans that are now defaulting at a rate last seen during the days of the Financial Crisis.
And they’re big enough to knock the auto industry, one of the few booming sectors in the otherwise lackadaisical economy, off its record perch. An auto-loan implosion would start at subprime and work its way up, just like mortgages had done.
The business of “repackaging” these loans, including subprime and deep-subprime loans, into asset backed securities has also been booming. These ABS are structured with different tranches, so that the highest tranches – the last ones to absorb any losses – can be stamped with high credit ratings and offloaded to bond mutual funds designed for retail investors.
Deep-subprime borrowers are high-risk. Typically they have credit scores below 550. To make it worth everyone’s while, they get stuffed into loans often with interest rates above 20%. To make payments even remotely possible at these rates, terms are often stretched to 84 months. Borrowers are typically upside down in their vehicle: the negative equity of their trade-in, along with title, taxes, and license fees, and a hefty dealer profit are rolled into the loan. When the lender repossesses the vehicle, losses add up in a hurry.
Auto loans in general have been in a huge boom that reached $1.04 trillion in the fourth quarter 2015:
Equifax reported last year that 23.5% of all new auto loans where to subprime borrowers. So unlike the mortgage crisis, subprime auto loans aren’t in the trillions, but in the neighborhood of $200 billion. Many of them have been repackaged into asset backed securities. And these securities are starting to implode.
Auto loan ABS delinquencies reached 4.7% in January, the highest since February 2010, according to data from Wells Fargo, cited by Bloomberg. During the Financial Crisis, delinquencies topped out at 5.4%. During normal times, they range from 2% to 3%.
John McElravey, head of Consumer ABS Research at Wells Fargo Securities, warned that these delinquencies would entail a wave of defaults. The default rate is already skyrocketing. It hit 12.3% in January, up from 11.3% in December, the highest since 2010.
To continue reading: It Starts: Subprime Auto Loans Implode (in Your Bond Fund)
