Just like mortgages, many of those loans have been packaged into bonds, “securitized” in Wall Street parlance, and sold across the world to investors searching for yields in the wake of the financial crisis. Car loans was one of the best performing assets during that period.
Still, said Kevin Barker, a specialty finance analyst at PiperJaffray, the troubled auto loans are not likely “to create a financial crisis or cause major disruptions in financial markets.”
He cites several reasons for that. First, the car loans market, at $1.1 trillion, is a fraction of the $10 trillion U.S. mortgage market, according to the Federal Reserve. And auto loans are much shorter in length than 30-year mortgages, making it easier to spot trouble and prevent big losses from developing over many years.
“The credit cycle is short, so you will know pretty quickly when things start to improve,” Barker said. “You get hit and recover. It doesn’t take years and years and years.”
Risky auto loans actually play a role in keeping the economy going because people in rural areas, many of whom do not have access to public transportation, must have a car to get to work.
When labor conditions worsen, borrowers lose their jobs and cannot pay their loans.
“With unemployment at relatively low levels, we don’t see the auto market blowing up,” Barker said.
Since the end of the Great Recession, there’s been an explosion of auto loans as an improving economy and pent-up demand has spurred U.S. auto sales.
Along the way, lenders loosened their requirements of borrowers.
“Looser credit standards after several years of low losses (2010-13), as well as heightened competition, and lower recovery rates on defaulted loans are contributing to higher losses,” according to a March 20 report by S&P Global.
Lower prices for used cars are also adding to the losses when lenders foreclose on the auto loan. The lenders are getting less for the repossessed cars than they had expected.
“When you repossess the car, the value you thought you would get is even lower, resulting in a higher loss rate,” Barker said.
The result is lenders are increasing the interest rates on loans. They also tend to tighten their due diligence by ensuring people have a job and a higher credit score. Those moves are expected to hurt the sales of new U.S. cars, which have been hitting record levels for several years.