Rumors of a subprime auto-lending bubble have been greatly exaggerated.
Credit union experts and lending industry insiders say a collapse is unlikely in the subprime sector. In fact, the number of auto loans going to borrowers with subprime credit scores — 640 or lower — has been stable over the last several years, according to Equifax.
Subprime borrowers made up 31.2% of total loan originations at mid-year. While that's not an insignificant number, it is well below a peak in 2007, when the share of subprime auto loans reached nearly 37.3%.
"Having looked at some of the data in aggregate in the past, there's nothing to say that there's some tremendous issue going on," said Dennis Carlson, deputy chief economist at Equifax. "The reason it's gotten so much play is everybody loves to talk about bubbles, and it's very easy to pick on subprime in general."
Delinquencies have started to tick up, but that makes sense given the growth of the subprime market, said Melinda Zabritski, senior director of automotive finance at Experian. Concerns only mount when "lenders aren't planning for an increase in delinquencies," she said.
Carlson pointed out that the anecdotes highlighted in recent stories in The New York Times and other national publications are generally focusing on predatory lending practices. Undeniably, such things unfortunately do happen. "But subprime lending does not equal predatory lending," he noted.
To be sure, the subprime sector helped kick off the housing bubble. But the frenzied market dynamic in 2007 was very different than what the automotive industry is experiencing today.
Car sales are on a steep climb back to pre-recession levels, but vehicle production is keeping pace with demand, which has been pent up for the past several years as many consumers held off on making large purchases, say industry experts. That was not the case in real estate pre-recession, when construction of new homes greatly outstripped demand.
Another indicator that concerns of a bubble may be overblown is the fact that subprime auto loans to borrowers with a credit score above 600 have increased 24% since 2006, according to Equifax data. "This suggests a tightening of subprime lending standards rather than a loosening," Carlson wrote in a research report he co-authored.
But even if (hypothetically) a subprime auto loan bubble did blow, it would not affect credit unions the same way it would banks, say insiders and experts.
"In the credit union world, we're more portfolio lenders, so we originate the loan and actually hold it on our books, even if we are granting more subprime loans," said Steven Rick, chief economist at the CUNA Mutual Group. "So we're not packaging those up, securitizing them, and selling them off to some Wall Street investors."
Still, CUs have seen explosive growth in both new and used auto loans, which are up 19.7% and 13.4% year to date, respectively, according to CUNA Mutual Group data. "We're seeing the fastest growth in auto loans since 1995. We're actually taking marketshare away from the banks," Rick said. In 2011 and 2012, new auto loans at credit unions were declining on an annual basis.
Part of the boom is thanks to the recovering economy and the pent-up purchase demand.
CUs Offer Competitive Rates
But some, like Compass Financial Credit Union in Medley, Fla., are seeing growth in auto loans because they offer more competitive rates than banks, among other reasons.
"Nine to 11% is our range for subprime, whereas for banks it's more the 18%-to-21% range," said Leo Acosta, president and CEO of the $23-million-asset credit union. The vast majority of Compass Financial's loans (80%) are car loans, half of which are subprime, he added.
By not gouging borrowers with exorbitant rates, credit unions avoid creating the kind of adversarial rapport that can develop with subprime customers who might feel taken advantage if they get upside down on a car loan. (For more on how Compass FCU keeps delinquencies in check, see related story on page 15.)
"A person looks at their car and says, Man, this thing's worth $5,000; I still owe $10,000.' They may just walk away from it," said George Jorge, an EVP at Compass. This is a particularly important distinction, given that many borrowers in the subprime credit segment today used to have good credit ratings before getting hit with hardships during the recession.
Our average credit score back in the day was 680, 690," Acosta said. "Now, when we see a 600 score, we're jumping for joy."
For members with a prime credit rating and solid financial track record, Lake State Credit Union of Isanti, Minn., will finance 100% of the cost of a new car — sometimes more if, for example, the buyer wants to add an extended warranty. But with subprime borrowers looking to get an auto loan, Lake State typically requires a cash down payment as much as 25%, said Vanessa Stusek, retail services manager at the $184-million-asset credit union.
"Their relationship with us plays a big part in our decision when it comes to some of those subprime deals," Stusek said. "For example, we're way more likely to make a subprime loan to an existing member versus someone coming through an indirect dealer, who may not have a relationship with a credit union."
This willingness to listen to members' stories and extend a loan to someone with a low credit score who might otherwise get denied elsewhere is one of the biggest advantages credit unions wield over banks, sources said. It is also a vital service to the community, in keeping with the credit union credo.
Lake State's loans to subprime borrowers have stayed flat, but new auto loan originations have grown to represent 19% of its overall loan portfolio year to date, up from 11% in 2008; while used car loans make up 10% of the portfolio, down from 15% in 2008. Stusek says staying on top of collections by getting in touch with delinquent borrowers early and often is key to managing risk, as is giving guidance to first-time car buyers.
"You've got the 21-year-old who's buying his first truck that wants to spend $45,000," Stusek said. "That's going to set him up for failure. So it's a matter of putting your members, both prime and subprime, in a monthly payment that will be comfortable for them for the long term to set them up for success."
Sources agree that, ultimately, subprime auto lending has been and will remain a crucial part of the overall business, one that extends credit to the most economically distressed consumers, who arguably need it the most.
"If they don't have a way to get to work, then they don't have a way of supporting their families. And it's just unfortunately a vicious cycle," Stusek said. "So yes, we have seen where subprime loans will help."