#subprime

Repossession by remote

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A growing number of car loans in the US are being pushed further down the repayment line as much as 84 months. In the new car market the percentage of 73-84-month loans is 33.8%, triple the level of 2009. Even 10% of 2010 model year bangers are being bought on 84 month term loans. The US ended 2016 with c.$1.2 trillion in outstanding auto loan debt, up 9%YoY and 13% above the pre-crisis peak in 2005.

Why is this happening? Mortgage regulations tightened after 2008 to prevent financial lenders from writing predatory loans, especially sub prime. Auto lending attracts far less scrutiny. Hence the following table looks like it does with respect to outstanding accounts on loans

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Sub Prime auto loans, at all time records, make up 25% of the total. Devices installed in cars let collection agencies repossess vehicles by remote when the borrower falls behind on repayment. This lowers risk and allows these long dated loan products to thrive. Average subprime auto loans carry 10% p.a. interest rates. More than 6 million American consumers are at least 90 days late on their car loan repayments, according to the Federal Reserve Bank of New York.

While it is true that $1.2 trillion auto loan book pales into insignificance versus the $10 trillion in mortgage debt at the time of the GFC, a slowdown in auto sales (happening now) isn’t helpful. The auto industry directly and indirectly employs c. 10% of the workforce and slowing new and used car sales will just put more pressure on prices further lifting the risk of repossessions

It is worth reminding ourselves the following.

Last month the Fed published its 2016 update on household financial wellbeing. To sum up:

“44%. This is actually an improvement on the 2015 survey that said 47% of Americans can’t raise $400 in an emergency without selling something. The consistency is the frightening part. The survey in 2013 showed 50% were under the $400 pressure line. Of the group that could not raise the cash, 45% said they would go further in debt and use a credit card to pay It off over time. while 25% would borrow from friends or family, 27% would forgo the emergency while the balance would turn to selling items or using a payday loan to get by. The report also noted just under a quarter of adults are not able to pay all of their current month’s bills in full while 25% reported skipping medical treatments due to the high cost in the prior year. Additionally, 28% of adults who haven’t retired yet reported to being largely unprepared, indicating no retirement savings or pension whatsoever. Welcome to a gigantic problem ahead. Not to mention the massive unfunded liabilities in the public pension system which in certain cases has seen staff retire early so they can get a lump sum before it folds.”

If only this perpetual debt cycle could be stopped via remote. Someone else’s problem one would suggest.

New cars for 40% off

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Looking for a new car? This maybe last year’s model but it’s new and 40% off. I recall seeing such lunatic deals the last time we headed for a collapse in auto sales. Mac Haik Ford in Houston is practically giving it away.  Even some of the 2017 models are getting chunky discounts.

Jim Glover Chevy near Arkansas River is also trying to shift 2016 metal. Why buy used when a 2016 new Malibu is $7,000 off?

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Chrysler is also chucking discounts left, right and centre. Northwest Dodge Houston is taking $14,000 off new Rams.

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ZeroHedge wrote:

If GM piles on incentives at this rate three months in a row, it would spend nearly $4 billion on incentives, in just that quarter, just in the US alone. How much dough is that for GM? In Q1 2015, GM reported global net income of $2.0 billion. In Q1 2015, it reported global net income of $0.9 billion. These incentives can eat an automaker’s lunch in no time. And they did in the years before the industry collapsed during the Great Recession.”

The National Automotive Dealer Association (NADA), a division of JD Power wrote,

Manufacturers dialed up incentive spending 18% last month to help reduce new vehicle inventory levels that are at a decade-plus high.”

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The NADA Used Car Guide’s “seasonally adjusted used vehicle price index fell for the eighth straight month, declining 3.8% from January to 110.1. The drop was by far the worst recorded for any month since November 2008 as the result of a recession-related 5.6% tumble. February’s index gure was also 8% below February 2016’s 119.4 result and marked the index’s lowest level since September 2010.”

WolfStreet noted “Used vehicle wholesale prices determine the value of the collateral for $1.11 trillion in auto loans that have boomed on higher prices, higher unit sales, longer maturities (the average hit a new record of 66.5 months in Q4), and higher loan-to-value ratios (negative equity)”

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It doesn’t bode well.

NY Fed warning of next sub-prime crisis

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The New York Fed has published a report talking of the risk of sub-prime bonds becoming a potential time-bomb. Recall that cumulative sub prime defaults reached 25% in ’07.

Private sector sub-prime loan insurance was 20% of mortgage origination in the last crisis vs 3% for the government.

Now, the government is now 22% of new sub-prime mortgages. Ginnie Mae (i.e. John Q. Taxpayer) guarantees the principal and interest to any investors who buy Ginnie Mae bonds.

The Federal Housing Association (FHA) allows 96.5% loan to value ratios and if insured that cost is rolled into the mortgage pushing it to around 102%. 10% of those mortgages have FICO scores below 600 (which is really bad) and defaults at this end of the scale hit over 40% in 2007. The 5yr cumulative defaults on sub-prime originated in 2010 has seen <600 FICO score borrowers at 26.4%.

FICO scores rank as follows.

  • Excellent Credit: 750+
  • Good Credit: 700-749
  • Fair Credit: 650-699
  • Poor Credit: 600-649
  • Bad Credit: below 600

With my other posts I’ve highlighted the risks of a sharply slowing US economy and the Fed is becoming far more dovish on growth. Rates on hold, cap utilisation falling and NFP under pressure.

Sub-prime to fill the yield hole

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You know we’re running out of yield options when the investment banks are looking at products to cater to the sub-prime market. Clearly it is an area the banks don’t really want to touch. Never mind that, let’s try and railroad yield starved investors into 30 year products catering to riskier borrowers.

Of course these sub-prime products have been rated by the credit rating agencies (what a superb job they did with mortgage back securities etc).

I find it somewhat ironic that as the world economy is set to head into recession (or worse), such products are being introduced to lure sub-prime borrowers into buying properties. So the investment banks clip a nice fee on the sale of the product and the investor, if things get bad face the risk of defaults and the face value of their product getting smashed.

This has red flag written all over it.