Subprime Auto Loan Crisis Chronometer

Crisis /krīsis/: A turning point that results in a battle over loss allocation.

Will there be a crisis? Are we near one?

Practices and factors similar to those contributing to the subprime mortgage meltdown are now impacting subprime auto lending and related ABS. The gauges reflect our take on how they are impacting risks for lenders and investors.

The Subprime Auto Loan Crisis Chronometer shows the risk of battles over loss allocation.
Oct 2018
Lending Practices and Factors i
Subprime originations have trended down but securitization volume continues to increase. Subprime delinquencies in the secondary market are on the rise and have surpassed peak levels. Risky practices are exposing specific lenders and their investors to losses, as evidenced by the closure of a number of smaller subprime auto lenders earlier this year.
ABS Practices and Factors i
Credit enhancements such as excess spread, overcollateralization and subordination have increased in new deals and continue to create a buffer from riskiest lending practices. Investors have not yet felt the sting of riskiest practices.
Auto Market Risks i
New and used vehicle prices are at all-time highs, but sales incentives and high supply of off-lease vehicles are accelerating depreciation and driving up negative equity on trade-ins. Advances in technology will likely accelerate depreciation further.

Self-driving cars, car sharing and subscription-based vehicle services: these are destined to affect the auto industry in ways that will make the current sales slump and shift from cars to SUVs seem like a bump in the road. Predictions vary widely as to when the sea change in how we think about cars and how they fit into our lives will come, but its inevitable arrival is often portrayed as part of a brighter, safer, cleaner and more efficient tomorrow.

The dark undercarriage of this issue is the insidious effect that the technology, including artificial intelligence, animating changes in our use of cars will have on the nation’s work force. Sci-fi writers have embodied the threat of AI in cyborgs and the creepy computer from 2001: A Space Odyssey. The real threat is far more mundane, yet more powerful than any movie robot. It lies in AI’s creeping effect on the employment prospects of low-skilled workers, and, in turn the ability of the auto industry’s subprime borrower to make good on their loans. Technology advances are accelerating at a time when maturity dates are being extended on both new and used vehicle loans, with an increasing number of borrowers opting for 73-84 month terms on their auto loans. As employers continue to adopt automation, many borrowers may be at risk of losing their jobs before their loans mature.

Unlike previous waves of technological innovation, which lifted lower-skilled workers to better jobs (or at least similar jobs in other industries), the use of AI and automation is expected to simply wipe out lower-level job functions across many different industries, leaving the workers who occupied them few alternatives.

Automation has already eliminated many manufacturing jobs. Trucking is a space of obvious concern. And the retail sector is vulnerable as well. A McKinsey study suggested that over half of retailing activities can be automated. March labor statistics also showed major cuts to retail jobs, which is part of an ongoing trend. While lost coal mining jobs have been the subject of much mythologizing and Presidential attention, between 2001 and 2016, they pale in comparison to job losses at traditional department stores.

As a White House report on automation noted, studies have estimated that “83 percent of jobs making less than $20 per hour would come under pressure from automation.” Another study cited anticipated that less-educated workers are more likely to be impacted by automation than highly educated ones. These are the same low-income workers who so often end up as subprime borrowers. As the income disparity stretches between the innovators building self-driving car empires and the workers they have displaced, automation will only exacerbate the divide. Stephen Hawking wrote: “This is inevitable, it is progress, but it is also socially destructive.”

Subprime lending practices should be accounting for this darker effect of technology, and the ever-increasing prospect, as innovation accelerates and loan terms extend, that its effects on borrowers’ employment will ultimately impact loan performance. To the extent they are not, any increased risks that are passed along to borrowers in the future in the form of higher cost loans could be too much for the market to bear, negatively affecting the outlook for subprime auto lending going forward.

James Serritella, a partner in the Insolvency, Creditors’ Rights & Financial Products Practice Group of Davis & Gilbert, contributed to this post.