As I’m sure you’re well aware, the Fed raised interest rates by one quarter-point yesterday, stating that the economy is doing well.
Now this decision is certainly good news for Wall Street and the big banks, as they’ve been wanting higher interest rates for some time. But Yellen forgot about (or neglected) one particular industry that was already at risk.
It makes up one of the largest markets in the world and employs over 1.7 million people in the U.S. alone. And if the Fed raises rates again, as I predict they will…
This could be the next “bubble” to burst.
How Big Banks are Using the Fed to “Keep Up With the Joneses”
Whether it’s for status, safety, or reliability, people are always looking for newer and better cars to drive. But most people typically don’t walk into a dealership and put down a stack of cash for their vehicle of choice – so they finance their cars. The problem is, not everyone can get approval for the amount they need (if at all)… which is where subprime auto loans come into play.
A subprime auto loan is used to approve people with less-than-perfect credit scores or a limited credit history who need to buy a car. This type of loan typically carries much higher interest rates and may also include pre-payment penalties. And given these higher rates, subprime auto loans are among the most sensitive to interest rate changes.
Now one could argue that subprime auto loans helped propel auto sales in the U.S., but it didn’t come without risk – and that risk is growing by the day…
Back in February of 2016, the credit bureau, Experian, reported that auto loan delinquencies had hit a 6-month high. Of those loans, nearly 5% of subprime loans were delinquent by 60-days or more – the highest level since 2008 at that time. Financial professionals worried about the potential of those bad loans being packaged up and sold as securities, as we saw happen to mortgage-backed securities in in the 2015 movie, The Big Short. And if that did happen, the entire auto industry faced the risk of collapsing.
Fast forward to this month, and Experian has reported that U.S. subprime auto loans delinquencies are even higher than they were before the financial crisis about eight years ago. Losses for these loans came in at 9% in January, up from 7.9% in January 2016. And making things worse is that recoveries dropped to 34.8% – the worse since early 2010.
And this is only the beginning…
Banks and finance lenders are expecting their losses in the subprime areas to increase even further. Investors in bonds backed by these loans want higher yields, which would drive up borrowing costs for banks and finance lender. Put simply, they’re losing profits for this reason – and this will likely just get worse if the Fed sticks to its guns to raise interest rates aggressively. The other thing that concerns me is that, if something doesn’t change, enough of these delinquent loans could not only disrupt the economy – it could severely hurt the auto industry.
Now I don’t know if the lenders themselves are trying to “keep up with the Joneses” within their industry, but this long-time practice of lending loans that are unaffordable to many, and with little to no alternative payment options, has caused us to get to this point. Enough delinquencies could eventually come to a head and car repossessions steadily on the rise, too many people will be left without the ability to go to work and provide for their families.
So be aware of the banks and financer lenders who specialize in subprime loans – especially as interest rates rise. And if you’re considering investing in a bank or two, be sure to research the amount of exposure they have to subprime auto lending.
I’ll continue to follow this story and will send you any new developments…