April 10, 2014 4:55 pm
American subprime lending is back on the road
Many new loans are going to consumers who previously had little chance of getting funding
A few short years ago, “subprime” was almost an expletive. During the financial crisis, mortgages linked to subprime borrowers – or those with poor credit history – caused devastating losses; so much so that many asset managers declared they would never touch subprime again.
The historical echoes are uncanny. During most of the past decade the amount of car-related debt grew only modestly. Yet outstanding car loans, which totalled $700bn in 2010, have jumped by a quarter in the past three years. This has led to a sharp increase in car sales, benefiting groups such as General Motors.
But car finance – along with student loans – jumped in that same month. Even more notable is that this has occurred amid a sharp deterioration in loan quality. Five years ago, subprime loans represented barely a 10th of the total; today they account for a third. A particularly high proportion of GM cars sales are financed by subprime loans.
Meanwhile, a 10th of new loans are now going to so-called “deep subprime”, or consumers who would previously have had little chance of getting funding – particularly given that incomes for poorer households have stayed flat or declined, even as car prices jumped.
However another reason for the boom is that savvy private equity firms and hedge funds have jumped into the fray, backing a plethora of new car finance companies in the past three years.
These have pushed loans to consumers in creative ways, and it has been a highly lucrative game: consumers can pay almost 20 per cent interest for subprime loans, but finance companies’ funding costs can be a mere 2 per cent, due to voracious investor demand.
Thus far there is little sign that this boom is causing tears. Default rates on car loans remain low by historical standards, at about 1 per cent. Still, if interest rates rise, defaults will almost certainly jump, particularly if incomes remain flat.
Credit rating agencies are starting to get uneasy. Some of the smartest Wall Street players are quietly cashing out. Some financiers are now so convinced that a crunch looms that they are furtively shorting automotive stocks such as GM, on fears that a loan crunch will hit car sales. That may explain why shares in the car company have slid so sharply this year, even beyond what could be explained by the recent embarrassing scandals over faulty ignition keys.
But if nothing else, this little saga is a stark reminder that parts of America’s current recovery are built on wobbly foundations. And it is another timely illustration – if any were needed – that cheap money has a nasty habit of creating distortions in unexpected places; even if they do not usually occur in exactly the same place as before.
Copyright The Financial Times Limited 2014
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