Subprime doesn’t mean “low income.” It means “bad credit” – and some is high income. And subprime loans are coming home to roost.
By Wolf Richter for WOLF STREET.
The balance of auto loans and leases rose by 0.8% in Q4 from Q3, and by 3.5% year-over-year, to $1.61 trillion, according to data from the New York Fed’s Household Debt and Credit Report.
This was a small year-over-year increase in loans and leases, given that new-vehicle unit sales jumped by 12% in 2023 year-over-year, while used-vehicle unit sales were roughly flat, and while disposable income jumped by 7%.
Spiking prices caused loan balances to jump in 2020-2022. Used-vehicle retail prices spiked by 55% and new-vehicle retail prices by 20% during the pandemic, and so the amount financed surged, even as unit sales plunged in 2020 and 2021 due to the shortages.
Starting in mid-2022 and through 2023, new-vehicle prices began to level out, rising just a little, while used-vehicle prices entered into a historic tailspin that has now knocked out one-third of the pandemic spike.
Combined, the new-and-used-vehicle CPI spiked by 31% from January 2020 through September 2022, and has since then dipped about 2%.
The amount financed is dominated by new vehicles because 80% of new vehicle buyers finance or lease a new vehicle, but only 39% of used vehicle buyers finance or lease; the rest pay cash (data by Experian, based on registrations).
The combined new-and-used-vehicle CPI is also dominated by new vehicles because new vehicles cost more than used vehicles and weigh more in the CPI basket (new vehicles weight 4.2%, used vehicles weight 2.5%):
The auto-debt burden dipped. Rising disposable incomes have more than kept up with rising auto-loan balances. Total auto loans and leases outstanding dipped to 7.8% of total disposable income, lower even than during the years before the pandemic.
Disposable income is income from all sources except capital gains, minus taxes and social insurance payments. This is the income that consumers have left to spend.
There are two reasons for this dip in the burden: slightly more buyers are paying cash for their new and used vehicles as interest rates have surged; and disposable income has jumped by 7% year-over-year.
Subprime is called “subprime” for a reason — and it’s not income.
Selling and lending to customers with subprime credit rating is a high-risk high-profit specialized activity, largely limited to older used vehicles. It has attracted specialized lenders and dealers, often backed by PE firms. The system hinges on being able to securitize the subprime auto loans into Asset Backed Securities (ABS) and sell the investment-grade tranches of those ABS to pension funds and other yield-seeking institutional investors, and that works until it doesn’t.
Bad loans are made in good times. During the free-money covid era, specialized subprime dealer/lenders loosened their credit standards and got very aggressive and very greedy. At the same time, used-vehicle prices surged. And the risks piled up. In 2023, several PE-firm-owned subprime-specialized dealer-chains filed for bankruptcy. Investors have gotten leery of buying the bonds that subprime auto loans are securitized into – and those ABS make the whole system work. And even the large publicly traded subprime dealer/lender Car-Mart disclosed massive problems in December, and its stock tanked.
And lenders are belatedly tightening their lending standards. About 61% of used vehicle buyers pay cash, according to Experian, and it doesn’t matter what credit rating they have. For those who borrow to buy a vehicle, the share of subprime has dropped to 14% of total loan and lease originations, down from 20% in 2018, according to Experian’s Q3 report. For borrowers with subprime credit ratings, financial conditions have tightened.
But subprime doesn’t mean “low income,” it means “bad credit” (a history of not paying debts, which caused their FICO score to drop into the subprime category). And subprime is only a small part of the used-car business and of the auto-lending business.
Subprime loans that are at least 60 days delinquent had hit a record in September but have since then backed off a little and in December were at 5.9% of total loan balances (red line in the chart below), according to the auto loans backing the ABS that are tracked by Fitch Ratings.
Prime loans are rock-solid with minuscule and relatively stable delinquency rates near 0.3% (blue).
Overall delinquency rates, according to the New York Fed’s metrics: The 30-plus-day delinquency rate – auto loans and leases that transitioned into delinquency by the end of Q4 – rose to 7.7% in Q4, a little higher than in the years before the pandemic, when it ranged mostly from 7.0% to 7.4%.
The 90-plus-day delinquency rate – auto loans and leases that are 90 days or more past due by the end of Q4 – rose to 4.2%:
Delinquencies rise the most in the lowest-income zip codes.
In a blog post, the New York Fed grouped the delinquencies by zip codes into four income categories from lowest-income zip codes to highest-income zip codes, and found that delinquency rates drop as income levels rise. In addition, it found:
In the lowest-income zip code category, delinquency rates rose more sharply and exceeded 2018 by a big margin, 12.8% v. 11.7% (light blue in the chart below). It is these low-income borrowers that are behind the increase in auto loan delinquencies above their pre-pandemic levels. These low-income borrowers are also the ones who are struggling the most with inflation — including the price spike in vehicles that they’re now having to make payments on.
In the three higher income zip code categories, delinquency rates were either just below or just above their 2018 levels – they essentially just normalized from the free-money drop during the pandemic.
That even the highest income zip code category (dark blue in the chart below) had an auto-loan delinquency rate of 4.6%, or any delinquencies at all, demonstrates that “subprime” doesn’t indicate “income” but “bad credit,” and that bad credit happens even to people with high incomes if they get into debt too deeply, if there is a major uninsured medical issue, etc. (chart via New York Fed):
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