Subprime is, as always, in trouble, which is why it’s subprime – high-risk-high-profit auto sales & lending that can entail steep losses.
By Wolf Richter for WOLF STREET.
To depict how consumers are handling their auto loans and leases, we look at three delinquency measures: the 60-plus-day delinquency rate for all auto loans and leases, including subprime, reported by Equifax today; the 60-plus-day prime delinquency rate and the 60-plus-day subprime delinquency rate, both reported by Fitch.
The 60-plus-day delinquency rate for all auto loans and leases ticked up along seasonal lines to 1.44% in June, from 1.41% in May, and from 1.40% in June a year ago, and was well below the seasonal highs over the winter that had topped out at 1.66% in January, per Equifax data today.
During the Free-Money era of the pandemic, delinquency rates had dropped below 1%. But the monthly Equifax data that is available doesn’t go back further than the low point of the Free-Money era and therefore lacks the comparison to the pre-pandemic normal years (red in the chart below).
Prime-rated auto loans are nearly always in pristine condition. The 60-plus day delinquency rate of loans that had been rated prime at the time when they were originated ticked up to 0.34% in June from 0.32% in May, and from 0.29% a year ago, and were well below the winter high of 0.39% in January, according to Fitch, which rates asset-backed securities (ABS) backed by auto loans. Even during the Great Recession, the prime delinquency rate maxed out at only 0.9% (blue in the chart).
Subprime is always in trouble which is why it’s “subprime.” Fitch’s subprime 60-day-plus delinquency rate rose to 6.31% in June along seasonal patterns. The seasonal peak was in January at 6.56%, an all-time high. Compared to a year ago, the delinquency rate was 69 basis points higher (gold in the chart).
Subprime means “bad credit” – a history of being late in paying obligations, or not paying them at all. It does not mean “low income.”
And subprime is just a small specialized part of auto lending: Of all auto loans and leases outstanding, only about 14% were rated subprime and deep-subprime at origination, according to Experian data.
Subprime lending has its own ecosystem. Nearly all subprime auto loans financed the purchase of used vehicles, mostly older used vehicles sold by specialized subprime dealer-lender chains, or financed by specialized subprime lenders. Subprime deals come with very high interest rates and very high prices on their vehicles. It’s a specialized high-risk-high-profit part of auto lending.
Lenders package these subprime auto loans into ABS and sell the bonds to pension funds and other institutional investors that buy them for their higher yield. The lowest-rated slices of the bonds take the first losses, but also offer the highest yield. When things go wrong, they can get wiped out quickly. Their job is to protect the highest-rated slices of these bonds. So when losses occur, they’re spread across investors that got paid to take those losses, not banks.
PE firms got into this subprime dealer-lender business, and a few of those chains collapsed when interest rate rose. Publicly traded America’s Car-Mart [CRMT] got hit too, and its shares have plunged by over 70% and joined our imploded stocks. So subprime is not for squeamish investors.
Total balances of auto loans and leases for new and used vehicles rose by $13 billion in Q2, after falling by $13 billion in Q1, and is back where they’d been in Q4, according to the New York Fed’s report on consumer credit.
The reason auto loan balances rose 25% since 2019 is because prices spiked from 2019 through mid-2022, not because more people are borrowing to finance purchases – they’re not.
The CPI for new vehicles has surged by 21% and the CPI for used vehicles by 34% over the same period. Those price increases caused balances to rise since 2019.
But the number of accounts of loans and leases peaked in 2019 at over 90 million accounts and then began to decline, in part due to the plunge in new vehicle sales amid the shortages in 2021 and 2022. It bottomed out in 2022 and has since then inched higher.
In June, the number of accounts remained at 87.1 million accounts, up a hair year-over-year, but still down from the peak in 2019, according to Equifax data today.
The burden of auto loans and leases. Debt-to-cash-flow ratios are classic measures of borrowers’ ability to deal with the burden of their debt. With households, a metric of cash flow is “disposable income,” which represents the cash households have available to spend after payroll taxes.
Disposable income excludes capital gains. It’s income from after-tax wages, plus income from interest, dividends, rentals, farm income, small business income, transfer payments from the government, etc.
Disposable income rises with higher incomes at individual households and with more people working and making money (population/job growth):
- QoQ: disposable income +1.25%, auto debt: +0.8%.
- YoY: disposable income +4.5%, auto debt: +1.8%.
With auto debt rising more slowly quarter-over-quarter and year-over-year than disposable income, the debt-to-income ratio declined (improved) to 7.3%:
Turns out, the vast majority of our Drunken Sailors, as we’ve come to call them lovingly and facetiously, is managing their auto loans and leases just fine. And subprime is, as always, in trouble, which is why it’s subprime.
In case you missed the earlier parts of the debts of our Drunken Sailors:
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Nice charts.