Bursting The Subprime ‘Bubble’

A recent report from Equifax Inc., which noted that originations and total outstanding balances for subprime auto loans have hit recent highs, triggered an alarmist article on subprime lending in The New York Times. In the July 19 piece, authors Jessica Silver-Greenburg and Michael Corkery cited anecdotes that leave the impression that fraudulent practices are widespread. They castigate the “high” interest rates on subprime loans without mentioning the high rate and expense of default and repossession. Repos can reach a third of originations, and collection practices — which are expensive to begin with — are a challenge on these loans.

Through April, 2.6 million subprime loans were originated, representing 32% of all auto loan originations, according to Equifax. The outstanding balance of those subprime loans totaled $46.2 billion, an eight-year high. Equifax defines “subprime” as loans to customers with credit scores of 640 or below. As a matter of record, though, in some circles, a loan is deemed subprime when the credit score drops to 580.

The American Financial Services Association and other industry professionals have since weighed in on the NYT article, noting that it enflames already-riled regulators. And Derek Kreindler, managing editor of TheTruthAboutCars.com blog, writes: “Don’t expect that 32% figure to let up anytime soon. The glut of credit available for auto financing — driven by securitized subprime auto loans being sold as investment-grade instruments — is going to keep the auto financing business alive and kicking for the foreseeable future.”

I have seen many articles trumpeting the danger of the expansion of subprime without proper context. It is one thing to have data, but quite another to interpret it properly. In the Equifax report, Deputy Chief Economist Dennis Carlson called the increase in subprime lending “good news,” adding that “a fully functioning second-chance market is essential for a healthy economy.”

I would be pleased if people would stop acting like subprime auto financing had a damn thing to do with the global economic meltdown in 2008. It didn’t. Subprime auto financing is nothing like the subprime home lending issues of the past decade, and $46 billion of total outstanding balances on all subprime loans is miniscule compared with the size of the overall economy and a drop in the bucket compared with the mortgage market.

Meanwhile, the ratio of subprime auto originations, including the buy-here, pay-here sector, has hovered around the 30%-to-35% mark for more than a decade. After all, more than a third of the population has a credit score below 640. Kind of makes sense, right? People need cars, and those originations include new and used loans, although they are mostly used.

To be clear, despite the sky-is-falling tone of the NYT piece, Equifax said “serious” delinquencies of 60-plus days remained near all-time lows, and represented less than 1% of total outstanding balances.

A quick call to Melinda Zabritski, director of auto finance at credit bureau Experian, revealed the following: First, the Great Recession spurred the average credit score of U.S. consumers to take the hit one would intuitively expect. Second, when credit dried up, many people — except for the highest credit score consumers — turned to BHPH or subprime finance, as one might expect. The stat cited in the NYT article compared subprime originations today with the dark days of the credit crisis, when capital for that kind of lending had completely dried up. Why pick a point in time that is obviously an anomaly, if one is trying to tell a story in real context?

Third, lenders are looking at the near-prime and subprime markets in a search for yield unavailable in the highly competitive prime lending space. Fourth, fast-track credit — the point at which a dealer can send a contract to a lender without first calling it in for formal approval — is now 720, up from 690. There are more strict debt-to-income and loan-to-value parameters, as well. Fifth, and perhaps most importantly, millions of consumers have been able to rehabilitate their credit through subprime financing — and there will be millions more. An accurate portrayal of the subprime market would have at least mentioned this.

There are some who equate subprime auto lending to mortgages made under the Community Reinvestment Act. Nothing could be further from the truth. CRA mortgages are not inherently subprime. According to the Federal Reserve, CRA mortgages have outperformed the mortgage market overall.

Also, as a matter of record, most of the mortgages that soured during the mortgage crisis were not subprime. Many people with excellent credit walked away from mortgages where they were paying off, for example, $450,000 on a $250,000 home. Yes, their credit score took a hit, and they might have had to get a subprime auto loan to buy a car. It will take some time to repair all the damaged credit. This has played its own part in the slow economic recovery.

Despite the NYT piece, clearly fueled by a desire to create controversy where the facts don’t indicate controversy exists, it’s time for everyone to take a deep breath and keep both feet firmly planted on the ground. There is no subprime bubble.

David Ruggles has spent his career in every phase of the retail side of the auto business, new and used, sales and management, including consulting and training in both the U.S. & Japan. Ruggles has been a dealer for Mercedes-Benz, Chrysler, Dodge, GMC, Ford, Mazda, and Subaru, and has consulted for one of the world’s largest privately owned Toyota dealer groups located in Japan. He blogs at autosandeconomics.blogspot.com and writes regular columns for several publications.