Deep Subprime Auto Loan Delinquencies Reach 2007 Levels: The Next Big Short?

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Subprime auto delinquencies have staked up so much that we are back at 2007 milestone levels.

deep subprime

There’s a section of the auto-loan market — known in industry parlance as deep subprime — where delinquency rates have ticked up to levels last seen in 2007, according to data compiled by credit reporting bureau Equifax.

“Performance of recent deep subprime vintages is awful,” Equifax said in a slide show on second-quarter credit trends.

Analysts have been warning for years that subprime car loans pose a threat to lenders as delinquency rates have edged higher since reaching a post-recession low in 2012. But it wasn’t until last quarter that the least creditworthy borrowers started to show the kinds of late payment profiles that accompanied the start of the financial crisis.

“We’re seeing an increase in delinquencies across all credit scores, but in the highest credit quality, it’s just a basis point or two,” Chief Economist Amy Crews Cutts said in an email Tuesday. “In deep subprime, the rise is more substantial. What stood out to me was the issuers. Those that have been doing this for a decade or more were showing the ‘better’ performance, while those that were relative newcomers were in the ‘worse’ category.”

The reason for the increase, she posited, is that lenders have loosened underwriting requirements as more firms tap into a declining market for car loans, not that there are more customers with worsening credit profiles.

“It isn’t a case of chasing a larger subprime share,” Cutts said in an email Tuesday. There’s been “almost no change in median credit scores. That means they are letting other underwriting characteristics slide,” she said, referring to the lenders that issue the bulk of subprime loans — so-called monolines that specialize in one area of the credit market and dealer-finance companies that work specifically with car sellers.

“As soon as lenders (and the investors behind them) get overconfident that they have better models and can make excess profits by disrespecting credit risk, they always get their hats handed to them sooner or later,” Cutts said. “The mortgage market learned this lesson at the expense of the entire global financial system, and it is playing out now in a micro-level, in the ABS market for subprime auto loans.”

The Next Big Short?

Some expect subprime autos will be the next big short, but there is plenty of disagreement.

  1. May 16, 2017: Steve Eisman says Don’t look for a sequel to ‘The Big Short’ anytime soon.
  2. March 27, 2017: The Daily Reckoning says “Big Short” 2017: When the Auto Industry Implodes.
  3. April 20, 2017: former Fed Advisor to Fed Richard Fisher makes the case that households have been squeezed to death and subprime auto loans could be the next major problem for the economy. Video below.

My Take

We likely will not see a credit meltdown in the US like we saw on 2007.

However, subprime loans of all sorts will get smacked hard. So will junk bonds.

A credit crisis in the Eurozone is possible, if not outright odds on. The European banking system is a mess.

Equities are due for a huge slide, but it may take many years to play out as opposed to a quick crash.

Eclipse Chasing

Greetings From Paducah, Kentucky. I will be just across the border in Goreville, Illinois on Monday hoping to get pictures of the total eclipse.

The amount of preparation for this has been incredible. I have been testing computer to camera interfaces to have my computer trigger ISO and exposure changes at the right time. Will do a final test today at the location where I will be tomorrow.

My article posting has been minimal the last couple days and eclipse testing is why. Monday will likely be another low-count article day.

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