Looking under the Hood of the Subprime Auto Lending Market

by Andrew Haughwout, Donghoon Lee, Joelle W. Scally, and Wilbert van der Klaauw – Liberty Street Economics, Federal Reserve Bank of New York

Today, the New York Fed released the Quarterly Report on Household Debt and Credit for the second quarter of 2014. Aggregate debt was relatively flat in the second quarter as housing-related debt shrank, held down by sluggish mortgage originations. But non-housing debt balances increased across the board, with especially strong gains in auto loans. Auto loan balances, which include leases, have increased for thirteen straight quarters, and originations have not been this high since the third quarter of 2006. The Quarterly Report and the following analysis are based on data from the New York Fed’s Consumer Credit Panel, a nationally representative sample drawn from anonymized Equifax credit data.

Once again, news reports are pointing to a boom in subprime auto lending, and the concerns raised by such a boom and its associated risks have prompted a Justice Department investigation. Last year, amid similar stories, we published the post “Who Is Driving the Auto Lending Recovery?” which showed that 23 percent of auto loans were originated by borrowers with credit scores below 620. This share, though significant, is still lower than the 25 to 30 percent share seen during the years preceding the Great Recession. We’ve now revisited these statistics, and find again that the share has increased only slightly since 2010 (see our interactive charts).

So what has all the fuss been about? The small increase in the share masks the fact that the subprime auto lending market has grown substantially over the last several years, as the chart below shows.

Since the trough in 2009:Q4, balances have risen across the board, but the growth has been most pronounced among the riskier groups, which also experienced the most severe contraction during the credit crunch of 2007-09. The dollar value of originations to people with credit scores below 660 has roughly doubled since 2009, while originations for the other credit score groups increased by only about half. These gains in origination volumes reflect an increase in the average size of the loans more than an increase in the number of loans.

One advantage of our data is the fact that we can infer whether a particular auto loan was made by a bank (including credit unions) or an auto finance company, typically affiliated with a car manufacturer. The two segments are roughly equal in size: in 2014:Q2, auto finance companies originated 53.7 percent of the new loan balances. The chart below shows the breakdown of lending by these two sources of funds. The left panel shows that auto finance companies’ lending to subprime borrowers was hit very hard by the crisis: between mid-2006 and the end of 2009, originations to the below-620 group fell by more than two-thirds. Conversely, in the recovery, subprime lending by auto finance companies has shown considerable strength: since the trough, auto finance company lending to each of the three lowest credit score groups has more than doubled. In contrast, the right panel shows that banks’ lending to subprime borrowers has historically been lower than that to prime borrowers, and despite the increase in recent subprime originations, the share of subprime borrowers remains small. This difference in risk appetite between banks and finance companies is reflected in delinquency rates; while the quarterly flow into thirty-day delinquency for bank loans has been about 1 percent in recent years, it was about 2.5 percent for loans by auto finance companies.

So, subprime auto lending is definitely on the rise in absolute terms, although the increase in prime auto lending over the same period makes the relative increase in the subprime share less pronounced. This resurgence in subprime loans is stronger among auto finance loans, where subprime lending is—and always has been—more prevalent than bank loans. We will continue to monitor this ongoing change in the consumer lending market.

Chart Data

Disclaimer

The views expressed in this post are those of the authors and do not necessarily reflect the position of the Federal Reserve Bank of New York, or the Federal Reserve System. Any errors or omissions are the responsibility of the authors.

Source: http://libertystreeteconomics.newyorkfed.org/2014/08/just-released-looking-under-the-hood-of-the-subprime-auto-lending-market.html#.U-zkZPldUSg

About the Authors

Andrew Haughwout is a vice president in the Federal Reserve Bank of New York’s Research and Statistics Group.

Donghoon Lee is a senior economist in the Bank’s Research and Statistics Group.

Joelle W. Scally is a research associate in the Bank’s Research and Statistics Group.

Wilbert van der Klaauw is a senior vice president in the Bank’s Research and Statistics Group.