Since the sub-prime mortgage collapse in the US back in 2007 there has been much focus on sub-prime loans and the risks which they bring to the table. The sub-prime mortgage market is under constant scrutiny but there does not appear to be the same kind of scrutiny for the sub-prime auto loans market. This is an area which has increased dramatically over the years, from $2.5 billion back in 2009 to a staggering $26 billion in 2016. So, should we be concerned about the auto loans market and how might this impact the US property sector?
At this moment in time there are various legal actions going through US courts involving Chrysler and Santander and their joint venture sub-prime auto loans business. While there are so far unproven accusations of misconduct and a lack vetting customers applying for loans, it is the potential knock-on effect which is most concerning. We’re not suggesting that the sub-prime auto loan industry will crush the financial sector as the sub-prime mortgage industry did but it could have a knock-on effect to the US property sector.
Wall Street ignoring the risks
There are rumours and counter rumours, truths and lies and everything else in between. Santander has just monetised a $1 billion bond which has been sold to Wall Street investors. The bond is backed by sub-prime auto loans amid accusations that only one in 10 customers saw their income vetted before the loans were approved. This has been denied by Santander and Chrysler and is currently going through the courts. These bonds have become very popular with investors as they offer a 5% yield which compares extremely favourably to savings rates, US base rates and the average dividend yield. So, should we be concerned about the US property market and any knock-on effect from the auto loans industry?
When you bear in mind the size of the current sub-prime auto loans industry any turbulence in the short, medium and longer term would create more financial stress for consumers. If rates were to increase in the short to medium term this could overstretch finances and lead to potential issues with mortgage payments. A knock-on effect from this could be enormous, some families will be forced to sell their homes, house prices would soften and potentially start a downward spiral. Nobody is suggesting that we are at this stage yet, but any turbulence in the financial markets/money markets would have a detrimental impact right across the board.
Cleaning up the system
While there is talk of cleaning up the sub-prime auto loan industry with stricter regulations and stronger vetting of customers it could be too little too late. We have seen the impact of contagion in financial markets back in 2007 with much of the knock-on effects are still being felt today. Even though a collapse in the sub-prime auto loan market would have nowhere near the same impact, it would push rates higher and increase the risks associated with funding money markets and so the cycle starts again.