Those questions were posed by listener Danny Ginsburg after Sean O'Reilly and I talked about the pros and cons of investing in the Detroit automakers on the Energy and Industrials episode of last week's Industry Focus podcast. (You can find a transcript and a video copy of the podcast here.)
Danny and I both think that other listeners might have had the same questions, so he graciously agreed to let me use his questions and my answer to him in this article. Here's an edited and expanded version of the response I sent to him.
Is a subprime auto loan "bubble" brewing?
Some big-name industry figures think so. Jamie Dimon, CEO of JP Morgan Chase, said earlier this month that he thinks subprime auto lending is "a little stretched... someone is going to get hurt."
Dimon went on to say that "someone" won't be JP Morgan Chase, which has very little subprime auto exposure. That's also true of the captive-financing arms at Ford and GM. While a systemwide breakdown in auto lending would obviously hurt all of the automakers, when it comes to the potential direct impact of rising subprime delinquencies on the automakers themselves, I think the bubble talk about auto loans is a little overblown.
That said, there are some legitimate concerns. Here are two big ones: Dimon is right when he says that subprime lending has been rising, and the terms of (even high quality) new-car loans are getting longer.
Why subprime auto loans aren't like subprime mortgages
Subprime auto lending has been rising. A report from credit bureau Experian last month noted, "The volume of vehicle loans and leases held by nonprime and subprime consumers increased by 9.5 percent and 10.9 percent, respectively [in the first quarter of 2016 from the first quarter of 2015]." That slightly outpaced the 8.9% growth in prime loans and leases, the report said.
But does that mean a collapse is coming? Generally speaking, the risks of subprime auto loans are not like the risks of subprime mortgages. For starters, there's a big difference in how the collateral is handled: It's much easier to repossess (and resell) a car than it is to evict a defaulted homeowner and resell the property.
Part of what happened with mortgages in 2008 was that credit tightened sharply as a glut of repossessed homes was coming on to the market. Few people were willing and able to buy, and so home values dropped quickly and sharply. Because the used-car market is much more liquid, that's not likely to be a concern. But that said, a glut of repossessed used cars coming on to the market all at once could drive prices down. That in turn could affect new-car leasing rates, which are based in part on the projected values of the cars at the end of the leases.
Ford and GM don't have a lot of direct subprime exposure
As for Ford and GM specifically, both do have captive financing arms (in-house banks), but subprime lending at both Ford Credit and GM Financial is a modest part of the portfolio and it's well-managed. Neither has been an aggressive player in the subprime market, and neither would be at huge risk if subprime auto-loan defaults were to suddenly start rising.
We should note that they don't appear to be rising yet, at least not at the two automakers' financial units. GM Financial's (worldwide) net credit losses were 1.9% of retail receivables in the first quarter, roughly flat year over year. Ford Credit's were even lower, at least in the U.S.: just 0.44%.
The Experian report noted that while 30- and 60-day delinquencies were up in the first quarter from a year ago, they're still modest: "The overall percentage of total delinquent loans remains relatively low when compared to pre-recession levels."
The trend toward longer-term loans might be a concern
The longer loan terms are also raising eyebrows. Not long ago, few auto loans went beyond 60 months, but now 72, 84, and even longer terms are becoming more common. According to Experian, the average term of a new-car loan in the first quarter was 68 months, up from 67 months a year ago.
In a sense, longer-term loans have been good for Ford and GM: The longer-term loans have allowed people to choose more lavishly optioned vehicles, and vehicles with higher trims have fatter profit margins. And today's vehicles are better-built than ever, meaning that there's not much question that a new 2016-model Ford or Chevy will last much longer than six or seven years with reasonable care.
But there are concerns: Are people more likely to default on longer-term auto loans? And do longer loans (and more durable cars) mean that people will be postponing the next new-car purchase?
There's not much evidence to support the first concern quite yet -- but the economy has been decent, and it's hard to know what will happen when the next recession strikes. As for the second concern: the average vehicle on U.S. roads is over 11 years old right now. From the industry's point of view, that means there might still be some pent-up demand out there. Longer-term loans aren't likely to change that any time soon.
The takeaway: Right now at least, the risks to GM and Ford are modest
Long story short: While it's possible that concerns about a loan bubble are hurting the prices of Ford and GM shares, I don't think we're at risk of a 2008-style meltdown in auto loans. Even if subprime defaults start to rise, Ford and GM have only modest direct exposure. And as for lengthening loan terms, I think the default rate will be something to watch if the economy starts to deteriorate. But at least right now, I'm not too concerned.