From the Department of How Soon They Forget: Subprime is making a comeback.
So far it is largely confined to the auto lending sector. But, given recent history, the natural question is whether subprime — which, strikingly, has kept its old name — could spread and prompt a replay of the financial crisis.
Many experts believe that the increase in subprime auto loans in recent quarters foreshadows developments in other areas of consumer credit, and that it is only a matter of time before the financial industry reverts to the fervid lending of yore, making high-rate loans to less-than-creditworthy individuals with no capability of paying them back.
Others actually see it as a positive development — an indication that lenders are feeling more upbeat on the economy — and not a cause for panic just yet. "Given how conservative a lot of lenders have been I don't think it's necessarily a bad thing," said Claude Hanley, a partner at the consulting firm Capital Performance Group. "Let's face it. People really need automobiles so I'm not surprised to see there's an uptick in activity in auto financing for subprime customers.
"When there's a big stampede and a lot of people rediscover the subprime space, that's when you could have a problem. But I don't think we're there yet."
According to data from the credit bureau Experian, financing for both new and used vehicles to borrowers with credit scores of less than 680 was up 2.9% in the first quarter from a year earlier, encompassing 41.89% of all financing. That follows a 5.5% increase in the fourth quarter.
The data is evidence of "a lot of things that are taking place right now," said Melinda Zabritski, director of automotive credit at Experian. "You have a very strong wholesale car market. When a borrower does go delinquent, and you have to repossess the vehicle, you are not losing that much money on the vehicle. The assets are certainly worth more than they historically have been. You also have, as the market is now turning, as sales increase, lenders returning to the market. That's all leading now to increased competition in the finance market."
One of the ways lenders will expand and compete to gain more market share is to "go lower in the credit spectrum," Zabritski said. "That does not mean we are anywhere near where we were back in 2007. But we're certainly seeing an increase in subprime."
Interest rates vary widely by car and borrower, but April data on annual percentage rates from Edmunds.com showed lenders charging 10% or more on sizable concentrations of loans for certain makes such as Dodge and Kia.
Just because subprime lending is on the rise in the auto sector, though, does not necessarily mean lending standards are running unchecked, one lender said.
"We've all been very consistent and diligent in going back into the nonprime market in a heavier volume mode … but making sure the credit we are putting on our books has every opportunity to be successful," said Kyle Birch, executive vice president of dealer services at GM Financial, the financing arm of General Motors Co. "The people that are in the marketplace today are very rational about doing the right things. You always have some level of concern with new entries into a competitive landscape and what exactly would they do to gain market share. But I feel very comfortable with the space."
Underscoring the increasing interest in subprime, last July GM created a captive finance unit by buying the subprime lender AmeriCredit Corp., known as GM Financial today. It re-entered financing after selling a majority stake in GMAC (now Ally Financial Inc.) several years earlier.
Banks still command the biggest share of the more than $600 billion auto lending market, though total outstanding balances of auto loans at banks have declined. They dipped 2.6%, to $225 billion, in the first quarter, according to Experian. But banks' share of the subprime pie has been increasing. In the first quarter, it rose to 26.36% from 25.21% in the fourth quarter, Experian said.
Some said they believe subprime auto lending will increasingly become more of a niche play, with big lenders reducing their exposure and captive finance companies like GM Financial and other nonbank finance companies picking up share.
"It's not really the customer base [banks are] looking for for growth and cross-sell and the like," said Terry Moore, managing director of Accenture credit services. "I think we'd want to draw a distinction between the larger lenders and maybe some niche players."
For the foreseeable future, most experts say subprime is likely to remain confined to auto lending.
For one, subprime loans — traditionally defined as those made to borrowers with low credit scores (typically 620 or below) — never really went away in the auto sector in the aftermath of the financial crisis as they did in other areas of consumer credit, most notably mortgages. Auto lending has remained a somewhat specialized lending segment, dominated by players who have been in it for a long time. Cars are a necessity for all types of borrowers so people tend to pay off their cars before other loans. And unlike housing, car values never plummeted, and sales have stayed robust. (New-car sales totaled 3.1 million in the first quarter, up 20% from a year earlier, according to Edmunds.com.)
Perhaps most importantly, though, regulators have left the auto industry largely untouched.
"Auto is just sort of different than mortgage lending in particular because a lot less attention has been paid to it," said Chris Kukla, senior counsel for government affairs at the Center for Responsible Lending. "Because it wasn't directly implicated to the meltdown, it's been treated differently."
Auto lending may garner more attention from regulators in the future, Kukla said. But for now, the regulatory impediments to subprime lending in other areas of consumer credit, notably mortgages and credit card loans, are greater. In the mortgage industry, specifically, a proposal that would require lenders to retain 5% of the credit risk of loans they securitize is expected to deter any type of loan that isn't a "qualifying residential mortgage." QRMs will require at least a 20% down payment from borrowers and compliance with certain debt-to-income ratios — bars that many in the industry say are too high and will likely preclude a lot of borrowers from having access to mortgage credit.
"On mortgages, it hasn't really been sorted out," Hanley said. "Some of the regulations are still evolving. The risk-retention rules, that would clearly have to be factored into whatever profit model there is going to be for subprime mortgage."
And regulations like the Credit Card Accountability, Responsibility and Disclosure Act of 2009, which restricted banks' ability to raise interest rates, charge late fees and other actions on consumer credit cards, may constrain lenders from jumping back into subprime credit cards with gusto.
"Unlike autos, you have a fundamentally different regulatory structure that the card lenders have to be mindful of," Hanley said. "They don't have quite the flexibility that they had in prior years to price for risk and make money from subprime people."
Subprime got a bad rap when it became the go-to term for all kinds of different risky loans that were at the center of the mortgage crisis. So naturally, some are still wary of the word.
"We have to distinguish high-risk lending from the practices that were going on," during the boom, said Robert Lawless, a professor at the University of Illinois College of Law who specializes in consumer credit issues. "Both high-risk lending and reckless lending practices have been traveling under the umbrella of subprime right now. Hopefully we have gotten rid of things like no-document loans and negative amortization mortgages and progressions of that nature. What won't surprise me is that financial capital will find borrowers willing to pay high interest rates because they are risky borrowers."
While some of the new regulations are likely to curb such practices, subprime's place in banking going forward will largely depend on outside factors. "What determines whether the banks will make these loans or not is the state of the economy, the amount of excess funds that are floating in the economy and the need for the banker to generate earnings growth as rapid as his peers," said Richard Bove, a banking analyst at Rochdale Securities LLC. "There's no question in my mind that bankers will make these loans again and that there will be losses on these loans as great as there were in the past. And there's no regulation or rules that will stop this from happening again."
