As a former real estate economist now firmly ensconced in the automotive industry, I've enjoyed comparing and contrasting the trends, drivers and characteristics of the two industries that represent the biggest purchases consumers make.
Despite all of the negative headlines suggesting automotive lending could be the next financial disaster, I've developed a new appreciation for auto lending's overall health and importance.
Subprime lending plays a key role in the automotive market, yet the media often portray subprime lending as a problem part of the market, implying there shouldn't be subprime lending at all.
Perhaps the negative bias is because some equate subprime lending with predatory lending (which is unequivocally bad and not limited to the subprime segment). Or maybe some believe all subprime lending is just too risky. That latter perspective borrows a housing bubble "lesson learned" that is inappropriate for the automotive market.
Context is key to understanding data. Looking at the volume of subprime loans or even subprime loan performance without appropriate context enables doomsday purveyors to insinuate subprime lending is bad in and of itself.
The data suggest otherwise. The share of auto loan origination dollars with a VantageScore 3.0 credit score under 620, which is commonly used to define subprime, has averaged 18.8 percent of auto loans over the last 13 years, according to data from Equifax.
Over that period, the share has ranged from a low of 13.1 percent in the third quarter of 2009, when the worst of the financial crisis was coming to an end, to a high of 24.5 percent in the first quarter of 2007, when credit was too loose in almost every sector of the economy.
Year to date through June, the subprime share of origination balances stood at 18.4 percent. By historical context, subprime auto lending is far from being dangerously high. As a percentage of loan dollars, 20 percent is probably about right.
We did see an expansion of credit in auto lending in recent years as the share of subprime loans reached a post-recession peak of 21.9 percent in May 2016. As you would expect, loan performance has deteriorated as a result. Severe delinquencies stood at 0.91 percent as a share of balances in June 2017, up from 0.83 percent a year ago, according to Equifax. Severe delinquencies reached 1.53 percent in January 2009 during the Great Recession.
Lenders rightfully responded by tightening loan standards, including requiring higher down payments, increasing required credit scores and increasing rates and reducing term lengths on riskier applicants.
The market adjusted the choke, and bingo, the default rate declined and now the engine sounds healthy again. In fact, the June default rate fell to a 13-year low, according to the S&P/Experian credit index for auto loans.