Should Bank Investors Be Worrying About Subprime Auto Loans?

Over the past few years, there has been a large increase in the number of subprime auto loans, -- those made to borrowers with far less-than-perfect credit profiles. Many investors hear the word "subprime" and immediately have flashbacks to the dark days of 2007 and 2008, when defaults on subprime mortgage loans triggered a global economic meltdown.

In this segment from The Motley Fool's Industry Focus podcast, host Gaby Lapera and analyst Jay Jenkins discuss subprime auto lending in its broader context for special guest, Motley Fool intern Emily Flippen. While a bubble in auto lending could in theory burst and create losses for banks and investors, the potential downside is much less severe than we saw during the mortgage crisis.

However, taking the quality of a bank's loan portfolio into account is vital when deciding whether or not to invest in its stock. This discussion of subprime auto lending lends itself to that bigger consideration, a point that Gaby and Jay are quick to make to this summer's Foolish interns.

A transcript follows the video.

This podcast was recorded on Jun. 20, 2016. 

Emily Flippen: Our next question is actually coming from a fellow investing intern, Ben. Ben's wondering, as the rate of auto lending, particularly subprime auto lending, has increased to record highs, are there any financial companies that are overly exposed to this subprime auto loan market that could adversely impact the company's performance?

Jay Jenkins: I'm going to skip around the answer directly to make a bigger point. Subprime is kind of a dirty word. The mortgage crisis burned in everyone's brain that subprime is bad. But we need to remember that, subprime back in 2008, in the mortgage market, was extremely widespread. Something to the tune of 30% of the mortgages originated at the very peak of the bubble were subprime. And that bubble, when it burst, was so massive. It had led to problems literally everywhere, it trickled to the commercial market, and the residential market. And it had broad, sweeping impacts on the labor market, the whole economy all over the world.

Subprime auto-lending is much smaller than subprime mortgage ever was. In terms of the banking industry, if there is a subprime auto bubble and it bursts, there'll be impacts, there'll be losses from it, but it'll be nothing like what was experienced in 2007, 2008 and 2009. However, some banks will have more exposure than others. But in general, auto-lending is a pretty small component of a bank's larger book of business. Generally, mortgage lending is most, then some commercial real estate lending, then other times it'll be, commercial and industrial lending, lines of credit for working capital needs and so forth. And only then do you get into these consumer loans like auto loans or personal loans.

I wouldn't worry too much about the subprime auto loan market specifically. It's good practice, if you're going to invest in a bank or lender, to look at their loan portfolio and see if they have any concentrations in general, and make sure you're comfortable with that concentration before you dive into the investment.

Gaby Lapera: Definitely. Just an FYI for listeners, when you say subprime, they're referring to your credit score. Credit scores range from, I think the lowest I've ever seen is 300, but they range from potentially lower than that to 850. Subprime is considered anything below 600. I have an Automotive Financial Lending report pulled up right now, and it looks like the states with the greatest default levels are energy states, which isn't that surprising right now, because if a bank has a lot of customers that are reliant on the energy sector, and the energy sector was down for a while -- because this is from Q1, so who knows what it looks like exactly right now -- but it's not surprising if a lot of people are defaulting because they don't have a job anymore.

Jenkins: That's right.

Lapera: But, you're right that it's totally up. It's just something to keep an eye on.