Subprime auto lending has seen a large spike since the depths of the financial crisis, and that has many drawing a direct comparison to subprime mortgage lending. From the second quarter of 2009 up to the fourth quarter of 2014, subprime auto-lending saw an increase of nearly 100%. While a raw number like that can make for dramatic headlines, history tells us such extreme examples should always be given proper context and perspective.
For instance, according to Standard & Poor’s, sub-prime auto lending, while nearly doubling since 2009, is actually 27% below peak levels reached in the fourth quarter of 2005. Furthermore, analysts at S&P Ratings points out, “Super prime auto loan originations (credit scores greater than 760+) are at record levels as of the second quarter of 2014 at $27.9 billion.”
A deeper dive shows that what might seem like a straightforward comparison of auto and mortgage subprime loans is much more complex.
What’s your definition of subprime? While many reports from press, academia and the US Government often quote statistics on “subprime” lending, there is actually no universally accepted definition. For instance, in the auto sector, according to S&P “The market generally considers loans with [credit scores] lower than 620 as subprime.” But the federal agency that oversees housing, HUD, defines subprime as anything with a FICO score between 580 and 659.
The FDIC weighs in with even broader criteria. It states that subprime loans “…display one or more of these characteristics at the time of origination or purchase.” Characteristics include: recent late pays, judgments, collections or previous bankruptcies among a list of other criteria, including credit scores.
In addition to different definitions among cars and homes, historical performance shows quite a compelling contrast. Look at this chart from the beginning of the Aughts through 2013. Auto loans have significantly outperformed mortgage loans through the crisis.
Size Matters. The size and scale of subprime loans in the auto sector are dwarfed by what was being originated in the housing market at the frothy heights of 2005 to 2007. At the bubble’s peak, subprime mortgages totaled around $1.3 trillion in volume. Subprime auto loans today? According to data compiled by Equifax and published by the Federal Reserve Bank of New York Consumer Credit Panel, approximately $20.6 billion in subprime auto loans were originated in the second quarter of this year, which would equate to roughly $80 billion for all of 2014.
This extreme difference in volume of loans is vitally important when estimating any true systemic risk. And it’s not just the economy as a whole, but important to remember that whereas residential mortgages were a significant part of some of largest banks’ balance sheets, the auto loans are proportionally smaller as well.
Structural Differences. Finally, subprime auto and mortgage loans are just different in almost every way.
Almost 90% of all subprime mortgages were not the original purchase loans, but a refinanced loan. Subprime loans became widespread when borrowers, discovering rising home values, turned to refinance mortgages to borrow against their newfound equity. Among the most popular type of refinance mortgages was the adjustable rate mortgage (ARM). After an initial period with a low introductory rate, say 6 or 24 months, the loan payment would reset higher, causing severe payment shock for the borrower. This was ultimately the catalyst that set in motion many delinquencies and defaults. Auto loans are only structured with fixed payments.
Finally, millions of borrowers turned to second mortgages to further strip cash from rising values or buy homes with little to no down payment. This was a major trend in home finance, and an option that simply does not exist in the auto world.
Anxieties regarding subprime auto lending are understandable, but ultimately misplaced when compared to the subprime lending leading up to the crisis. Just as our grandparents turned in to a nation of thrifty savers following the Great Depression, Americans today will likely have some permanent psychological change following the Great Recession.
But any change should be tempered by reality, and looking at a broad array of data shows that people need to be careful when comparing subprime auto loans and subprime mortgage loans.
Jason R. Gold is the Director of Global Government and Public Policy at McGraw Hill Financial, the parent company of Standard & Poor’s Ratings, and an adjunct professor at Georgetown University.