Last week we talked about credit-card/consumer debt, and how those debt figures seem to be trending higher year after year (click here to read that post). This week, we want to look at another contributor to increasing debt figures.
Since 2012, the number of outstanding auto-loans is up by 57%. GDP growth over that period has grown about 22%, credit cards are up by 21%, and mortgages by only 11%.
Why have auto loans increased more than other forms of debt?
Sub-Prime lending.
If that term sounds familiar, it is probably because you lived through the 2008 financial crisis and housing market crash. In a race to the bottom, banks were eager to offer mortgages at sub-prime rates to anyone who walked through their doors. Poor quality borrowers were borrowing as much as they could to purchase real estate. This inflated the housing market to the point of it’s eventual crash as the higher risk sub-prime lenders couldn’t service their mortgages.
Today we find something similar happening in the auto-loan industry. Loan dealers are lending to people that, prior to 2012, would not have been eligible to receive a car loan. These weaker borrowers are more likely to become delinquent even during strong economic times.
Why are these weaker borrowers receiving loans? High quality borrowers/purchasers are always going be there regardless of economic situation. The answer is simple, dealerships, car manufacturers, and lenders want to grow aggressively.
If sales growth above the “higher quality borrower” market is the objective, it means lowering your lending standards and extending credit to potentially delinquent borrowers with poor credit ratings.
The iron rule of lending tells us that when you see a certain type of loan growing in total issuance, the lending standards are most certainly declining. Now, we definitely see an increase in vehicle loans…
There are 3 main lenders in: captive finance arms, bank-based lenders, and specialty lenders.
- Captive finance arms are owned by the manufacturer or dealer.
- Bank-based lenders lend across a wide spectrum, with some extending credit to sub-prime borrowers. These lenders have usually been in the industry for many years.
- Lastly, specialty lenders, who are mostly backed by private equity. This category is full of new entrants into the lending business that are trying to take advantage of cheap short-term capital and relatively high interest rates on subprime auto loans. (The delinquency rate for the private equity-backed lenders currently sits at roughly 14.3%.)
There are many new entrants into the auto-lending industry. Existing players who used to hold a majority market share are seeing a significant decline. In the USA, Santander and Americredit had a 86% market share in 2012. Fast forward to 2018, and that figure has dropped to 51%.
In conclusion, it would seem that the overall auto loan delinquencies are rising mainly due to the new market entrants who are allowing sub-standard borrowers to play at the table. The biggest problem being that, due to quick depreciation of a vehicle, the asset-to-debt ratio is an alarmingly low rate. The reality is, even if a delinquent borrower sold their car to pay off their debt, they would still have an outstanding loan balance.
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