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Subprime Car Loan Bubble 2.0 Full Frontal

With the total balance of auto loans for new and used vehicles approaching $1 trillion in the U.S., the folks at Experian want you to know that no matter what the numbers say, there’s no speculative bubble forming in the industry. Just ask Melinda Zabritski, the group’s director of automotive finance, who is quick to dismiss the growing chorus of Chicken Littles who are concerned about subprime auto lending:

Whenever there is an uptick in the number of loans to subprime and deep subprime customers, there is the potential for a 'sky is falling' type of reaction, [but] the reality is we are looking at a remarkably stable automotive-loan market, in part because consumers are continuing to stay on top of their payments.

That would be great if it were true. Of course the reality is that, according to the NY Times, early delinquencies (i.e. borrowers who have missed a payment within 8 months of origination) are at their highest level since 2008:

More than 2.6% of car-loan borrowers who took out loans in the first quarter of last year had missed at least one monthly payment by November, the highest level of early loan trouble since 2008 [and] more than 8.4% of borrowers with weak credit scores who took out loans in the first quarter of 2014 had missed payments by November [also] the highest level since 2008, when early delinquencies for subprime borrowers rose above 9%.

Combine that with the fact that the percentage of total auto loan originations made to subprime borrowers surged to 27% in 2013 (the highest level since 2006), the same year that 1.1 million U.S. households took out auto title loans (i.e. the new home equity loan), and you’ve got a rather strong argument for the contention that anything we learned in 2008 about the perils of loose lending standards has now been completely forgotten.

Reinforcing this point is Wells Fargo, who notes that things are now officially back to “normal,” where “normal” is amusingly defined by the conditions that prevailed in 2006:

Lending standards for households and corporations have eased to the extent that they resemble the last “normal” period of lending seen in 2006. Credit has expanded rapidly in some loan categories, which has in turn boosted spending and investment.

Of course the bad news is that Americans are again overextended at just the wrong time:

...should interest rates rise later this year, some households and corporations may find themselves overleveraged as interest rates and borrowing costs rise. When looking at interest rate sensitivity by loan product, we see that auto loans rates are the most sensitive to changes in the fed funds target rate. In addition, we can see that for each one-percentage point rise in the fed funds rate, the interest rate on a 48-month new car loan rises 0.61 percentage points.

The prudent thing to do, from a lender’s perspective, is to tighten standards when it appears borrowers are exhibiting a propensity to take on an undue amount of risk. Instead, standards are actually falling as risk-taking increases:

Although firms continue to ease lending standards, they have perceived increased risk among some loan types.

And, not surprisingly, recklessness is most prevalent in the two categories that have combined to underpin consumer credit growth post-crisis:

Among retail loans, student and auto loans saw the largest increase in 2014, as more than 40 percent of firms reported increased risk.

Most disturbing of all, lenders seem to have reverted to their pre-crisis mindset: “If we can sell the loan, who cares about the creditworthiness of the borrower?”

In 2014, a third of all firms originated retail loans with the intent to sell or hold the loan (as opposed to the sole intention to hold the loan). This trend indicates that some firms could be extending loans that they consider less creditworthy and could be eager to get these higher-risk loans off of their balance sheets.

As a reminder, ABS issuance hit its highest level since the crisis last year with student and auto loans accounting for the lion’s share. That's no coincidence.