Skip to main content

Advertisement

Advertisement

American subprime lending is back on the road

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.

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.

But the financial world has a short memory, particularly when easy money and innovation collide. In recent months, subprime lending has quietly staged a surprisingly powerful return, not in relation to real estate, but another American passion — cars. Some wonder how long it will be before this new boom causes another wave of casualties, not only among naive consumers, but investors too.

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 US$700 billion (S$875 billion) 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 (GM).

This upswing is striking, given that many other forms of consumer credit have remained weak since the 2007 financial crisis. Outstanding loans on credit cards, for example, have recently hovered near a 10-year low and data this week showed they fell unexpectedly sharply, by US$2.42 billion in February.

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.

WOBBLY FOUNDATIONS

There are several reasons for this boom. One is the fact that asset managers are currently so desperate to find something — anything — that produces a return in an ultra-low interest rate world that they are gobbling up all manner of bonds.

And investors are particularly keen to buy bonds backed by car loans because these performed better than mortgages during the last credit crisis. This has spawned a widespread (and potentially dangerous) assumption that American consumers are so attached to their cars they will do anything to retain them.

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, thanks 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.

These worries may be premature; people were muttering about the last subprime bubble years before it burst. And the good news is that even if subprime car financing does create a crunch, it will not necessarily cause that much systemic impact, since it is much smaller in size.

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. THE FINANCIAL TIMES

ABOUT THE AUTHOR:

Gillian Tett is markets and finance commentator and an assistant editor of The Financial Times.

Read more of the latest in

Advertisement

Advertisement

Stay in the know. Anytime. Anywhere.

Subscribe to get daily news updates, insights and must reads delivered straight to your inbox.

By clicking subscribe, I agree for my personal data to be used to send me TODAY newsletters, promotional offers and for research and analysis.