The Unnerving Thing Wells Fargo Just Said About the Auto Boom
American consumers are borrowing like never before to buy cars. It has been the reason why the US auto industry is intoxicated with its own exuberance. Last year, 16.5 million new vehicles were sold. This year, the industry hopes to breach the sound barrier of 17 million, or even 17.5 million. The industry is already dreaming about new all-time highs.
The growth is funded with borrowed money. Total auto loan balances outstanding grew 9.3% year over year to $975 billion at the end of December, an all-time high, according to Equifax. These balances will likely exceed the $1-trillion mark soon.
Auto lending to subprime customers – people with credit scores below 640 – has been particularly booming. Through October last year, 27.4% of all auto loan balances and 31% of the total number of auto loans were to subprime borrowers. Banks and subprime-focused specialty lenders convert these loans into structures securities, many of which carry triple-A ratings. They’re are selling like hot cakes, as bond fund managers gobble them up to create some yield in a world where central banks have expunged yield.
But bank regulators are warning about the auto lending spree. They’re worried about the ballooning loan-to-value ratios where the loan exceeds the “value” of the car by large amounts. Given that a car loses a lot of value the moment it drives off the dealer lot and continues to lose value, high LTV ratios raise the losses for lenders if the car is repossessed. But high LTV ratios also make the car expensive to finance. To keep payments down, loans are stretched to ludicrously long terms. And bank regulators are worried that these risky loans are made precisely to the riskiest customers.
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