Subprime cars: are auto loans leading us to the next financial crash? | Loan and debt


A huge increase in the amounts borrowed by already indebted households in Britain and the United States to buy new vehicles is fueling fears that “risk cars” could trigger the next financial crash.

British households borrowed a record £ 31.6 billion in 2016 to buy cars, up 12% from the previous year, the Finance and Leasing Association said on Friday. Nine out of ten passenger car buyers are now using personal contract plans (known as PCP), which have exploded since interest rates fell to historically low levels.

Under these cheap leases, buyers pay a small down payment and then agree to make a monthly payment for the next three years with the option of buying or returning the car at the end. The increase in PCP helps explain the skyrocketing car sales in Britain despite stable or declining household incomes. A record 2.7 million new cars were sold in Britain last year – the fifth consecutive year of increased sales. On a per capita basis, the British buy more new cars than any other major country in Europe.

UK auto finance is a ‘flashing light’, according to Andrew Evans, fund manager of investment firm Schroders. “Borrowing is a very bad idea when done against a depreciating asset… like a car,” he said, adding that there was a “serious level of fragility built into the system”.

In the United States, people also over-buy cars. Last year, the total stock of outstanding auto loans jumped to $ 1.1 billion (£ 880 billion) in the United States, prompting Harry Dent, a financial commentator, to ask: “Could cars be our death this time around?

At the end of November, the Federal Reserve of New York warned that the “delinquencies” of subprime auto loans were a “significant concern”. He said these loans were being taken out at a faster pace than at any time in his history.

The borrowing boom is fueled by websites that profit from ultra-low interest rates. The most popular in Britain is LingsCars, with a quirky design featuring a cat wearing a Chinese Communist Party helmet.

Lings Cars

The site made Ling Valentine, who describes herself as the “Car Leasing Queen of Dragons’ Den”, after an appearance on the BBC’s show, Britain’s biggest individual car seller. She transferred £ 85million last year, promising a brand new Ford Fiesta for £ 150 a month. Everything is sold under leasing.

These deals are part of a colossal build-up of debt in the UK, some of which is taken on by people with bad credit, and some experts warn of an uncomfortable parallel with subprime mortgages before the financial crisis .

Last month the Bank of England warned that consumer credit, including auto loans, was near levels not seen since the 2008 financial crash. The credit agency Experian, which monitors personal debt, told The Guardian that “the number of PCPs overall has quintupled (394%) over the past five years “.

Some of the auto leasing loans in the US and UK have been bundled into asset backed securities, for sale to investors such as pension funds. It was an asset class that played a ruinous role in the credit crunchexcept that this time the collateral for those assets is cars, not houses. The rating giants Standard & Poor’s and Moody’s have assigned most of these loan packages a triple A security rating.

Several banks will be involved in any “auto loan ABS” (asset backed security). For example, a A securitized £ 1.3bn bundle of UK loans issued by PSA Finance, a branch of Peugeot, included HSBC, Lloyds, Wells Fargo, based in San Francisco, and BNP Paribas in France.

When residential mortgage-backed securities collapsed in 2007-08, there was a domino effect across financial institutions around the world.

If asset-backed auto security crumbles, the pain is likely to fall mainly on the automakers who are backing their multibillion pound leasing arms. At the Bank of England, economists on his blog titled “Auto finance – is the industry accelerating? ”concluded that“ the industry’s growing dependence on PCP has made it more vulnerable to macroeconomic downturns ”.

He warned that “the manufacturer would be exposed [to] the depreciated value of leased and leased vehicles returned at the end of their contracts if the lump sum payments exceed the market values ​​of the vehicles ”.

One of the main concerns about the PCP market is that an overabundance of vehicles entering the used car market will drive values ​​down, pushing them below the expected sale value of the leased car after three years. . The cars will be returned to the manufacturers, potentially inflicting heavy losses on them.

S&P Global Peugeot ABS
Extract from a typical car loan securitization.

Another concern is “delinquencies,” which refers to defaulting on payment or arrears on a loan. If the economy collapses, as interest rates, unemployment or inflation rise, the ability of millions of people to maintain their loan payments will decrease and write-downs will skyrocket.

At the FLA, auto finance boss Adrian Dally remains optimistic. He said auto loans in Britain were only a small fraction of the £ 1 billion in mortgage debt. In the United States, that $ 1.1 billion in auto loan debt compares to over $ 14 billion in mortgages.

Dally said lending in Britain had been very disciplined, with little evidence of lending to subprime borrowers, and that the UK was “absolutely a world leader in terms of underwriting quality and minimizing risk” . Proof of this comes from the flaws and deficiencies, which are extremely small. In the Peugeot loan portfolio, for example, the default rate is only 0.08%.

Standard & Poor’s said it has stress tested the loan portfolios, incorporating scenarios such as a 45% drop in the value of used cars, and even if that happens, these securitized entities would remain viable. . He said that in the UK and Europe, write-downs on auto loans only amounted to 0.2% of outstanding loans. He added that the “term” of the loan was generally three years, not the typical 25 to 40 years for mortgages. The mountain of debt has been reduced in years, not decades.

Financial regulators had learned from the subprime mortgage crisis and were relaxed with the auto loan market, said Dally, himself a former regulator. “As you can imagine, the Bank of England is everywhere with a fine tooth comb.”

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