The auto lending bubble seems to be getting bigger

May 3, 2017

So, we have bad news and bad news. Which would you like first?

Fine, we'll start with the bad news. 

The U.S. auto market is cooling off. April's light vehicle sales were down 4.7 percent compared to those of April 2016, and year-to-date sales are off 2.4 percent across the board. Nearly all mass-market automakers reported April sales below April 2016 figures--not dramatically below, but below nonetheless. 

In other words, the auto market may not meet analysts' expectations of slight growth this calendar year. Though it doesn't appear that sales are hitting the skids just yet, we could be heading toward that word that makes economists and geography students cringe: plateau.

That's the bad news. And now for the bad news.

Americans have taken out roughly $1.2 trillion in auto loans, which is a record high. Approximately 25 percent of that total was signed for by subprime borrowers--that is, those with not-so-great credit scores.

Admittedly, credit scores fluctuate for a number of reasons, and a low credit score doesn't necessarily mean that someone is a credit risk for lenders. However, the odds of a subprime borrower defaulting on a loan are higher than those of a person with a FICO score above 640.

Worse, as we reported a couple of months ago, delinquencies on auto loans have hit highs not seen since 2008, as America began its long, painful slide into the Great Recession. And just as we saw nine years ago, many of today's delinquencies are associated with subprime loans. 

Also alarming is the fact that loan terms appear to be growing. The average auto loan is now 68 months, and about one-third of current loans linger for longer than 72 months.

That might be because average new-car prices are sky-high, but it might also be because the growing number of subprime borrowers need to spread out their loans over longer terms to lower monthly payments. Either way, not great news.

Economists aren't yet in a panic about all this. Many are concerned about the rise of delinquencies and subprime loans, but on the other hand, they note that mortgage delinquencies--a more important gauge of financial well-being--remain relatively low.

Just to be safe, though, some major lenders like J.P. Morgan Chase and Wells-Fargo have tightened their credit requirements for auto loans and edged away from the subprime market. However, smaller and more predatory lenders aren't always on that page.

Not all bad news

There are, however, two bright sides--well, one bright side, and one potential bright side.

First, there are plenty of deals to be had on new vehicles, especially on slow-selling cars.  In fact, the average incentive offered on new vehicles last month was over $3,300.

Second--and this is the potentially bright side--is the fact that truck sales remain strong. Even at companies like Ford and General Motors, which reported net losses for April, pickup sales were ahead of where they were at this point last year. 

Why does that matter? Truck sales are often seen as an indicator of economic vitality. Since pickups are often used for business--notably construction--strong truck sales suggest that companies are growing.

In other words: keep calm, carry on, but be on the lookout for trouble signs ahead.

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