Experts: Subprime car loans hurt sales, but crisis unlikely

An increase in the delinquency of risky auto loans probably won’t send the U.S. economy into the doldrums the way the mortgage loan crisis did in 2008-09, but it will likely pinch car sales, analysts say.

Borrowers are falling behind on most subprime car loans, but the situation for “deep subprime” consumers — those with credit scores below 550 — has deteriorated fastest, according to a report by Morgan Stanley.

Just like mortgages were, many of those car loans have been packaged into bonds, “securitized” in Wall Street parlance, and sold across the

world to investors searching for yields in the wake of the financial crisis. Car loans were among the best-performing assets during that period.

Still, said Kevin Barker, a specialty finance analyst at Piper Jaffray, the troubled auto loans are not likely “to create a financial crisis or cause major disruptions in financial markets.”

He cited several reasons for that. First, the car-loans market, at $1.1 trillion, is a fraction of the $10 trillion U.S. mortgage market, according to the Federal Reserve. And auto loans are much shorter in length than 30-year mortgages, making it easier to spot trouble and prevent big losses from developing over many years.

“The credit cycle is short, so you will know pretty quickly when things start to improve,” Barker said. “You get hit and recover. It doesn’t take years and years and years.”

Risky auto loans actually play a role in keeping the economy going because people in rural areas, many of whom do not have access to public transportation, must have a car to get to work.

When labor conditions worsen, borrowers lose their jobs and cannot pay their loans.

“With unemployment at relatively low levels, we don’t see the auto market blowing up,” Barker said.

Since the end of the recession, there’s been an explosion of auto loans as an improving economy and pent-up demand has spurred U.S. auto sales.

Along the way, lenders loosened their requirements for borrowers.

“Looser credit standards after several years of low losses (2010-13), as well as heightened competition, and lower recovery rates on defaulted loans are contributing to higher losses,” according to a March 20 report by S&P Global.

Lower prices for used cars are also adding to the losses when lenders foreclose on auto loans.

“When you repossess the car, the value you thought you would get is even lower, resulting in a higher loss rate,” Barker said.

The result is that lenders are increasing the interest rates on loans. They also tend to tighten their due diligence by ensuring people have a job and a higher credit score.