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Increase in Subprime Auto Loan Defaults Is Harbinger of Bad Future
Commentary by Charles M. Tatelbaum, Daily Business Review - Dusty Holoubek - March 15, 2016
In what is a very troubling sign for the nation’s economy, the default rate for subprime auto loans increased to 12.3 percent in January. This is a full percentage point increase over the prior month and an even greater increase over the prior year.
The default rate is now the highest rate since early 2010. This is extremely significant because billions of dollars have been gobbled up by interest hungry investors who are using securitized subprime auto loan securitization packages as an investment tool in a similar manner to what was done with home mortgages prior to the housing boom crisis which precipitated the Great Recession.
Subprime auto loans are a significant component of motor vehicle sales today, touching on both new and used sales of cars and trucks. With a segment of the populace being underemployed or still unable to gain appropriate employment after the recession and wages not increasing, credit scores have dropped, thus forcing those individuals to utilize subprime borrowing to purchase new or used vehicles.
Subprime financing is available not only at franchised dealerships in order to permit them to be able to make sales to customers with lower credit scores but also with used car sellers both at the franchised dealer locations and at the independent “buy here-pay here” facilities.
Investors’ appetite for high interest yielding investments to counteract the still historically low savings interest rate plus the incentives offered by manufacturers and dealers to continue the record pace of motor vehicle sales has contributed to this apparently insatiable appetite for high interest investments where there is a perception, but perhaps not the reality, of minimal risk.
Based upon historical perspective in the bankruptcy environment, this situation appears to be more significant than what may appear at first blush. Rising delinquencies are a warning sign that more loans may end up in default than the road. Securities backed by vehicle loans are structured to absorb a portion of anticipated defaults, but concerns are mounting that cumulative losses on vehicle loan securitizations may exceed initial estimates. Last Resort
Similar, yet different, from the prior housing boom-bubble, if the default rate increases even further, the result will be several fold.
First, subprime interest rates will increase even further to compensate for the additional risk. This, in turn, will drive up the amount of monthly payments needed to cover principal and interest for the subprime loans, creating hardships for those consumers already cash-strapped.
Additionally, because of the increased risk, the investors will require a greater down payment in order to further minimize risk, which also creates hardships for the consumers.
Lastly, as history has demonstrated, when the subprime auto loan market is negatively impacted, it has a detrimental effect on the sale of new and used vehicles.
The statistics also focus a spotlight on the subprime-hungry consumers. Bankruptcy experience has taught us that consumers will default on motor vehicle loans only as a last resort. Credit card bills, student loan obligations, medical bills and other unsecured debts and even secured credit will be unpaid before a consumer will risk defaulting on a motor vehicle loan.
Even with real estate mortgages, most consumers now know that it takes months or years before a foreclosure can be consummated with respect to a real estate default, yet the same consumers know that motor vehicle lenders will repossess vehicles shortly after even an initial default. Thus, when more than 12 percent of the subprime vehicle loans are in default, it presents a picture that is not pretty concerning the lower end of the consumer spectrum.
All of this will have a domino-effect impact on the economy. Investors who thought they had a virtually risk-free investment vehicle in the collateralized subprime loan packages will be dismayed to find that their return may be substantially impacted. Consumers will have a difficult time purchasing vehicles, and in turn history has shown that this creates an increase in both consumer and business bankruptcy filings.
Recently, the American Bankruptcy Institute released statistics for bankruptcy filings for the month of February. The statistics showed that the total bankruptcy filings increased 23 percent compared to the 52,542 total filings registered in January.
We can no longer rely on unemployment rates and similar broad-brush statistics to gain a true picture of the nation’s economy. Based on the dramatic increase in subprime auto loan defaults, the current perspective on the financial horizon is not necessarily good.
Charles M. Tatelbaum is the chair of the creditors’ rights and bankruptcy practice group at Tripp Scott in Fort Lauderdale. He has concentrated his law practice in the creditors’ rights area for 49 years. Read More