Market Commentary - June 2015

Many of the monthly market outlooks have discussed the economic benefits and risks associated with maintaining artificially low interest rates for an extended period of time. I'm as tired of writing about as many of you are reading about it. Alas, I can't seem to help myself. 

This month's topic...subprime auto lending. These are fixed interest rate loans given to people with substandard credit scores or limited credit histories. While there is no defined cutoff or credit score, the interest rate charged on these loans can be five to ten times that of prime borrowers. Subprime loans play an important role in allowing people with bad or limited credit a chance to purchase a vehicle which may be necessary for them to hold down an economically productive job. As long as lending standards maintain, these types of loans are a win-win for both lenders and consumers as it allow the borrowers to purchase a car while improving their credit.  The problem isn't with the existence of subprime loans. The issue is with the growing number of subprime auto loans.  They have increased by 302% since since 2010 and currently total over $20 billion.*

Subprime auto loans are very lucrative for the parties involved (lenders and private equity firms) and the troubling part is it has slowly evolved into maximizing profits for the lenders vs. making reasonable and quality loans to lower credit borrowers. The high returns on these types of loans has led to a loosening of credit standards even while delinquency rates are increasing. Subprime loans currently make up nearly 20% of all auto loans.

The pain from the subprime mortgage crisis still lingers today and while this subprime crisis is not nearly as large in size, it is troubling that the same risky lending standards of the past are creeping up again. One would think the past would serve as a good reminder, but when interest rates remain near 0% for nearly half a decade and profits are to be had, excess risk seems to be the default. 

With all this said, however, I wonder how many of these loans are being made to the millions who lost jobs during the recession and had their credit scores hurt but are employed again and just haven't built their scores back up yet. I think as long as the employment rates stay solid then the subprime auto loans will be "fine".