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The Next Subprime is Brewing
CAR LOANS
Hotep G&G Readers,
Next to the oil business, the other industry that has benefited most from the Fed's easy-money policies is the car business. Easy money has created a boom in subprime auto lending that's nearly an exact repeat of the subprime boom we saw in housing a decade ago.
Back then, people were buying houses they couldn't afford. Today, they're buying cars they can't afford. Honda Executive Vice President of U.S. Sales John Mendel put it best. He recently told the Wall Street Journal: "The industry is starting to do some stupid things."
See why he is saying this, the numbers are pretty scary:
Cars represent the last asset the average American can still borrow against. A record 84.5% of shoppers who acquired a new car in the last quarter of 2013 used financing. That's the highest level ever, according to Experian Automotive. More than 25% of these loans were subprime.
Used-car purchases required an average of $17,913 in financing over an incredible 61 months. Almost 60% of all used-car loans are subprime. This extraordinary expansion of subprime finance for automobiles has produced a boom in the car business. But... will the boom continue?
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The subprime loans that fueled consumer demand and set prices higher have begun to go bad. They're souring not because some people have lost their jobs, but because far too many people have purchased cars that they can't possibly afford. It's the exact same thing that happened after the subprime boom in housing.
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When it came to the housing collapse, there were multiple culprits. Overzealous lenders ... home buyers with no concept of personal finances ... and of course, asset-backed securities (ABS). Yes, plenty of greed, stupidity, and irresponsibility were going around in the mid-2000s housing bubble ... But it's fair to say none of it would have been possible without ABS.
Here's how it worked: Freemoney Mortgage would give Joe, a construction worker, and Pam, a teacher, a loan for $600,000 so they could buy a McMansion they couldn't really afford. Freemoney knew Joe and Pam were a huge credit risk ... and it sold the loan as quickly as possible to Middleman Inc.
Middleman then "securitized" Joe and Pam's mortgage ... which is a fancy way of saying it bundled the mortgage with a bunch of other McMansion loans and sold the entire package – called an ABS – to Big Bank. In turn, Big Bank received Joe and Pam's monthly payment ... along with thousands of other mortgage payments. For a while, things went well. In fact, Big Bank was able to borrow a bunch of money from Mega Bank by using the ABS as collateral.
Then, Joe and Pam missed a couple of payments because, you know, teachers and construction workers can't really afford $600,000 homes. At first, Big Bank didn't notice. After all, the risk of Joe and Pam defaulting had been "spread out" among the entire bundle of mortgages and priced in when the ABS was originally sold. Problem is ... Joe and Pam weren't alone. Turns out, Big Bank's ABS held the loans of thousands of Joes and Pams, who were all in over their heads.
Suddenly, everybody was defaulting. The ABS wasn't generating nearly as much cash as Big Bank expected ... and the value of the ABS had to be written down on Big Bank's books. That's when things really got ugly. Remember how Big Bank had borrowed money and used the ABS as collateral? Well... when the value of the ABS was written down, it immediately put Big Bank in default on its own loan from Mega Bank. Mega Bank demanded its money back. Big Bank didn't have it.
For a while, Big Bank whined and cried. It blamed Freemoney ... Then, it blamed Joe and Pam. Then, it blamed Mega Bank. But ultimately, almost every Big Bank not named Lehman Brothers got bailed out by the U.S. government. And to this day, the McMansion that started the vicious cycle – Joe and Pam's dream house – still isn't worth the $600,000 they originally paid. And that is how loose credit cripples economies and suppresses prices. When bubbles burst... assets lose value.
An unlit stick of dynamite is actually fairly harmless. And Freemoney's greed and Joe and Pam's irresponsibility are like that unlit stick of dynamite. The potential for calamity is there... but without a match, nothing much can happen. If Freemoney had no way to unload Joe and Pam's mortgage, there's no way it would have loaned the money in the first place. The ABS was the critical link in this string of events. The ABS was the match that lit the fuse.
These days, we have the exact same ingredients in place... with auto loans.
When it comes to car loans made to bad credit risks ... lenders just can't help themselves. The interest rates on subprime auto loans can climb up to 20%. And cars are a lot easier to repossess than homes. Lenders have actually figured out how to remotely disable cars when owners fall behind on payments. In many ways, this is actually a better business than mortgage lending.
Lets take a look at some of the biggest lenders in this industry. Santader Consumer USA - now has $26 billion in auto loans outstanding and an incredible 83% ($21 billion) of those are to subprime or "deep subprime" customers. Capital One is next, with $14 billion in subprime loans (34% of its book) followed by General Motors Financial, with $11 billion in subprime loans (71% of its loan book). That's a lot of risky loans to a lot of risky borrowers.
Take Santander as an example. Historically, Santander often held its loans on its books and held the risk of loss itself. While it still holds the risk for most originated loans, the company has changed its tune since going public. In 2014, Santander securitized around $7.6 billion worth of its auto loans and sold the risk – in the form of ABS – to others. The average credit score associated with these loans was 594. (Remember, anything less than 620 is considered "subprime.") The average interest rate on the loans was more than 16% and the average duration was more than 70 months. That's right... folks with bad credit are signing up to pay 16% annual interest for nearly six years.
But there are plenty more where that came from... The financial blog Zero Hedge – which has provided excellent coverage of the subprime auto debacle – recently reported that in 2014 alone, more than $40 billion of subprime auto ABS's were sold. We'll almost certainly surpass that in 2015.
So here we go again. A dynamite stick of greedy lenders... a fuse of irresponsible buyers...and a Kaboom waiting to occur.
But there's a big difference between today and 2008.
Back then, people stopped paying for their new cars because they lost their jobs at the same time they lost their savings in the stock market meltdown. It was the most severe economic crisis the U.S. had seen since the Great Depression. Today, in contrast, the stock market is approaching all-time highs, employment is rising, and average incomes are increasing. And yet ... loan defaults are high.
This dynamic suggests something has gone badly wrong in the underwriting and the funding of new car loans. And that means these losses are going to grow – a lot.
Of course, just like with the housing bubble... lenders will act as though they're providing a key service to the average working man/woman and anyone who questions their practices is downright un-American. The basic rhetoric goes something like this: "We're loaning money to hardworking Americans that need access to reliable transportation so they can go to work and contribute to the economy."
Look, I've got nothing against Joe and Pam. They play a critical part of the economy. But according to the latest statistics, if Joe's an average "deep subprime" borrower, he took out a $24,710 loan over a 67-month term for his brand new ride. It's likely he put nothing down.
Yes, Joe needs a way to get to work, but he doesn't need a shiny new $25,000 pickup to do so. And a $25,000 truck at 16% a year for six years is a $50,000 truck by the time it's paid off.
So just like 10 years ago when they overextended on a house ... Joe and Pam bought about three times more car than they could afford. And they borrowed money to do it. It's an eerily familiar position. A stick of dynamite with a lit fuse.
As always…feel free to pass this information on to anyone you think is interested in increasing their tax & financial IQ.
If you need a one-on-one consultation to learn how to implement these investments or any other tax or financial strategy mentioned in these newsletters, feel free to contact my office to setup an appointment.
Good Investing!
Ankh Uja Snb (Life, Health & Strength)
Asar Maa Ra Gray
Tax & Financial Consultant
G&G Associates
757-271-6068 office
866-361-3872 toll free fax
www.gngassociates.net
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“Investing is much like gambling. But, the difference is that with knowledge in investing you can at least increase your odds of winning.”
J. Carter
LEGAL NOTICE: This work is based on what I’ve learned as a financial researcher and analyst based SEC filings, current events, interviews, corporate press releases and what I've learned as a financial consultant. It may contain errors and you should not base investment decisions solely on what you read here. It’s your money and your responsibility. Nothing herein should be considered personalized investment advice.
If you need a one-on-one consultation to learn how to implement these investments or any other tax or financial strategy mentioned in these newsletters, feel free to contact my office to setup an appointment.
Good Investing!
Ankh Uja Snb (Life, Health & Strength)
Asar Maa Ra Gray
Tax & Financial Consultant
G&G Associates
757-271-6068 office
866-361-3872 toll free fax
www.gngassociates.net
Become a Fan of G&G Associates on Facebook & Twitter.
“Investing is much like gambling. But, the difference is that with knowledge in investing you can at least increase your odds of winning.”
J. Carter
LEGAL NOTICE: This work is based on what I’ve learned as a financial researcher and analyst based SEC filings, current events, interviews, corporate press releases and what I've learned as a financial consultant. It may contain errors and you should not base investment decisions solely on what you read here. It’s your money and your responsibility. Nothing herein should be considered personalized investment advice.
