The Federal Reserve is concerned about the subprime loans that are helping fuel the current automotive boom.
While carmakers were celebrating strong sales in November that are expected to aim the industry towards its second consecutive sales record, the Federal Reserve sent a signal that the industry ought to be a little bit more cautious about the subprime loans that have helped fuel the boom during the past couple of years.
In a press release issued the same day that sales figure appeared, the Federal Reserve Bank of New York, which keeps an eye on consumer credit noted in its latest Quarterly Report on Household Debt and Credit that there has been a “small” increase in overall debt in the third quarter of 2016, bolstered by gains in non-housing debt.
“Mortgage balances continue to grow at a sluggish pace since the recession while auto loan balances are growing steadily. The rise in auto loans has been fueled by high levels of originations across the spectrum of creditworthiness, including subprime loans, which are disproportionately originated by auto finance companies,” the New York Fed noted.
“Disaggregating delinquency rates by credit score reveals signs of distress for loans issued to subprime borrowers — those with a credit score under 620. In this post we take a deeper dive into the observed growth in auto loan originations and delinquencies,” the press release observed.
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In other words, more buyers are falling behind on their loan payments, which is one of the first and most worrisome sign that a contraction could be around the corner.
Ford Motor Co., for example, sounded an alarm last summer as the delinquency rates inched upward, suggesting the boom in new vehicle sales was beginning to slow.
“Originations of auto loans have continued at a brisk pace over the past few years, with 2016 shaping up to be the strongest of any year in our data, which begin in 1999,” the report from the New York Fed noted.
“The dollar volume of originations has been high for all groups of borrowers this year, with the quarterly levels of originations only just shy of the highs reached in 2005,” it added. “Although it remains true that banks and credit unions comprise about half of the overall outstanding balance of newly originated loans, the vast majority of subprime loans are originated by auto finance companies.”
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The report from the New York Fed also noted that auto-loan delinquency data indicates that the overall ninety-plus day delinquency rate for auto loans increased only slightly in 2016 through the end of September to 3.6 percent.
However, the relatively stable delinquency rate masks diverging performance trends across the two types of lenders. Specifically, a worsening performance among auto loans issued by auto finance companies is masked by improvements in the delinquency rates of auto loans issued by banks and credit unions, the report said.
“The 90-plus day delinquency rate for auto finance company loans worsened by a full percentage point over the past four quarters, while delinquency rates for bank and credit union auto loans have improved slightly,” according to the report.
“An even sharper divergence appears in the new flow into delinquency for loans broken out by the borrower’s credit score at origination, shown in the chart below. The worsening in the delinquency rate of subprime auto loans is pronounced, with a notable increase during the past few years.”
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In other words, at a time when new vehicles are selling for an $34,000 apiece, the number of sub prime borrowers falling behind on their payments is steadily increasing as carmakers push deals to bolster sales.