Subprime Auto Collections - A Growth Market for ARM Companies or a Bubble About to Burst?

Mike Ginsberg

As we recall, painfully well, the Great Recession was largely about a housing bubble created by consumers eager to borrow and investors desperate for profits. The warning signs of the developing financial crisis were silenced in large part by securitization and a lack of regulatory oversight. Is another bubble market emerging in the subprime auto sector? Perhaps, but a growth market for accounts receivable management (ARM) firms is fast developing already.

Just as many consumers purchased homes that exceeded their financial ability because financing was readily available prior to the financial crisis of 2007; many people with poor credit are currently buying cars with price tags that exceed their capability. This time, similar to the last go around, Wall Street isn’t directly lending to consumers. The loans are coming from smaller finance companies that sell the loans they make to bigger Wall Street firms that sort them from weakest to strongest credit scores, pool them together and sell them to their investors in a process called subprime securitization.

About $26 billion worth of subprime car loans will be made this year, far short of the $500 billion of subprime real estate securitizations made in 2006. Unlike real estate, cars are a lot cheaper, so this trend is  bound to impact a lot more consumers. Regulators are already starting to pay attention. The Consumer Financial Protection Bureau (CFPB) announced last week that it is proposing to oversee the larger nonbank auto finance companies.

CFPB Director Richard Cordray said, “Nonbank auto finance companies extend hundreds of billions of dollars in credit to American consumers, yet they have never been supervised at the federal level. We took action after we uncovered auto-lending discrimination at banks we supervise. Today’s proposal would extend our oversight, allowing us to root out discrimination and ensure consumers are being treated fairly across this market.”

Currently, the CFPB supervises large banks making auto loans, but not nonbank auto finance companies. The Bureau estimates that about 38 auto finance companies would be subject to this new oversight. These companies originate around 90 percent of nonbank auto loans and leases, and in 2013 provided financing to approximately 6.8 million consumers.

According to a recent article on insideARM, auto loans have long been an interesting market for ARM companies. Recent data shows that auto loans are growing at a rate similar to student loans, another attractive asset class for ARM companies and auto loans represent the second largest market of secured loans in the US behind mortgage loans.

Lenders, still reeling from the impact of the financial crisis, are increasingly willing to finance consumers with subprime credit scores. According to Patrick Lunsford’s article, the Federal Reserve Bank of New York (FRBNY) recently released a study of subprime auto lending with the following takeaway: “Since the trough in Q4 2009, balances have risen across the board, but the growth has been most pronounced among the riskier groups, which also experienced the most severe contraction during the credit crunch of 2007-09. The dollar value of originations to people with credit scores below 660 has roughly doubled since 2009, while originations for the other credit score groups increased by only about half.”

While delinquency rates on auto loans remain well below credit card and student loan rates, volume is growing at rates that exceed credit cards and run parallel to student loans, creating a growth market for ARM companies equipped to service this market segment.