Is There a Bubble In Auto Lending on the Horizon?

We are all familiar with different bubbles over the past two decades:  the bubble, the real estate bubble, the stock market bubble, and the mortgage debt bubble.  One can read of several new bubbles in the future like the student loan and sovereign debt bubbles.  The term bubble identifies an asset that has grown up to an unsustainable level.  The real problem is that when the bubble ends, it tends to pop, as compared to a slow deflation.

One possible asset bubble are auto loans.  We all see ads from auto dealers touting 0% interest deals in order to move slower selling vehicles.  Of course the 0% deals seems to be reserved for the best credit scored people.  Experian reports the average interest rate on new auto loans is around 4.7% in the first quarter of 2015.

But several alarming vehicle financing trends indicate we may be in the middle of an auto loan bubble.  Outstanding auto loans in the US have increased by 435 since quarter two of 2010.  Now auto debt has exceeded $1 trillion for the first time ever.  The 2nd quarter of 2015 had the fastest aggregate auto loan growth since 2005.

New loans have increased in duration as well.  Loan terms from 73-84 months now account for nearly 30% of all financings.  This seems concerning since there are weaknesses in the US economy with slow growth and nearly 94 million Americans out of the workforce.  If the US economy were doing so well, why are so many choosing a longer term loan so they can afford the car?  And what will happen if we experience a severe recession?

Another concern is the liberal credit standards.  Experian reports 28% of new loans are rated subprime or worse.  This is up 3.4% from 2013.  Subprime auto loans allow over-indebted consumers to buy a car they can’t otherwise afford.  If you wondered why auto sales are at 10 years highs, you only need the ability to fog a mirror to receive financing.  Can any say mortgage crisis?

Institutional investors are also buying some of these risky debts in order to find some yield.  Now the auto loan market is nowhere close to the size of the mortgage market.  So we probably are not dealing with a problem that will threaten systemic collapse.  Delinquency rates are also low with only 3.4% of auto loans currently at over 90 days late.  Compare this to student loan debt, which passed $1 trillion in debt in 2013, has a much higher delinquency rate at 11.5%.

The growing reliance on auto debt shows the debt addiction of US consumers continues.  Now household debt-to-GDP is around 77%.  This is down from a high of 96%, but is still above the 45% level in the early 1980s.

Many CUs tend to hold a healthy portfolio of auto loans.  Many of these are lower yielding assets which could result in much more maintenance in another economic downturn.  It may be good asset/liability management to look at your underwriting standards and exposure to auto loans.  If there is an auto debt bubble, when it pops, you will want to be prepared.