Wall Street deal-making is raising the specter of a subprime auto lending bubble much like the slice-and-dice, securities-driven mortgage bubble that brought the economy to its knees when it burst in 2008.
A sampling:
- Investment Riches Built On Subprime Auto Loans To The Poor says the headline in a recent New York Times article.
- New Debt Crisis Fear: Subprime Auto Loansdeclares a CNBC piece.
- Investors, driven to near insanity by the Fed’s interest rate repression, have developed an insatiable lust for structured securities backed by subprime auto loans. Wall Street blogger Wolf Richter.
In that column, Richter also discounts a new Equifax report that says based on its analysis of hundreds of millions of consumer records that subprime auto lending is growing at a steady pace, unlike the wildfire growth of the housing market and subprime and traditional mortgages from 2004 through 2008.
The Equifax analysts also say they found that subprime borrowers built their credit scores significantly. They add, Dire warnings that subprime auto lending is getting out of hand are generalizing the practices of predator and poorly originated lending as the norm for all subprime lenders, when, in reality, our data does not support those warnings.
In other words, with apologies to Porgy and Bess, it ain’t necessarily so.
While it doesn’t get into the possible reincarnation of toxic securities based on defaulted loans made to people who shouldn’t have gotten them, the Equifax report says subprime auto lending should get some kudos as much as kicks.
An increased negative media focus on some worst-case scenarios has drawn criticism to an industry that rather than a pointed finger deserves some recognition for weathering the storm of the Great Recession, and ultimately helping pave the way for our recent economic recovery, is how the report begins.
The big credit bureau has skin in the game, of course. It provides rating tools and services it says can help identify borrowers with low credit scores otherwise qualify for loans.
Credit union leaders specializing in serving lower-income lending say much the same, and point to very low delinquency rates as part of an essential intangible that speaks to the movement’s very reason to exist: to help people help themselves.
They also note that big national lenders have the infrastructure to make competing for prime borrowers a huge challenge for smaller credit unions. They also say that subprime borrowers offer a sweet spot financially, too, since credit unions can serve them profitably while seriously undercutting the rates offered by pay-here sales lots and payday lenders.
Read the short Equifax report titled Subprime Auto Loans: A Second Chance At Economic Opportunity for the number details and the pretty graphics.
Then consider these numbers:
- 56% of American consumers have subprime credit scores, according to the Corporation for Enterprise Development.
- 72% of 353 people who bought cars from the Ways to Work nonprofit reported higher income within two years.
- 25% of families with household income of less than $25,000 do not have a car, according to the Annie E. Casey Foundation.
- Zero. The number of loans written off so far by the 14 credit unions participating with the Filene Institute and National Credit Union Foundation in a non-prime auto lending pilot.
Those 2,600 loans comprise a $34 million portfolio grown in nine months by lending to people with an average credit score of 585 at an average interest rate of 11.6%, says Foundation spokesman Christopher Morris.
They represent what veteran credit union strategist Scott Butterfield calls a double bottom line the opportunity to make much-needed interest income while serving members as credit unions should.
Small to mid-sized credit unions can be the buffer between financial institutions who snub this market and predatory buy here, pay here’ lots who charge 30% interest, Butterfield says. How many of us would be willing to assume a 1% charge-off rate for an 8% average loan yield?
He adds, True, the business model is different than a risk-adverse, prime-only lender. But that doesn’t mean it doesn’t work. There are scores of credit unions that demonstrate it’s a very successful model when managed properly.
Not Quite Ready For Prime Time Credit
Tommy Cobb, CEO of Tuscaloosa Credit Union ($60.7M, Tuscaloosa, AL), knows that well. Since launching its Square One auto lending program in 4Q2013, TCU has made 90 loans for $833,000, basing its underwriting on personal factors that go well beyond credit scores.
We limit loans to purchases only, because refinances are usually too buried in negative equity, and to members who haven’t had a repossession for three years and who could satisfactorily explain credit bruises, like job losses and injuries, Cobb says. We also place a lot of weight on the interview process to determine a members’ motivation for getting a car loan. It might be because they’ve never had one, or it might that they can use the car to get a better job.
The longtime CEO says there are subprime lending lots in Tuscaloosa that lend without any apparent criteria than a down payment, and one might think that could lead to a bubble to form and burst because of borrowers who can’t exit their program. Our program is aimed to help members exit into our traditional loans. It’s a credit rebuilding step. Nobody starts out in life wanting to be a failure.
Pablo DeFilippi couldn’t agree more. A car is not a status symbol in low-income communities. It’s a ticket out of poverty and provides financial stability and security for an increasingly larger segment of our society, says the membership director of the National Federation of Community Development Credit Unions.
DeFilippi says a number of the Federation’s member credit unions offer deep subprime loans and that they provide an empiric testimonial now supported by the Equifax report that responsible financial institutions can do good by doing well.
Cobb at TCU can provide personal testimonial from a job and credit fair his Alabama credit union held last year. It included free credit report reviews and counseling from lending offers at local credit unions.
After her review, an attendee thanked one of the loan officers and told us that the only resource she had before that was to ask folks at the payday loan office for advice, Cobb says. Our Square One program has validated that our borrowers are not subprime borrowers, they’re just not quite ready for prime time borrowers.