Could This Trigger The Next Financial Crisis In America?
Mistakes of the past mean little to anyone in the modern banking industry. And now an unforgivable trend may have just hit its tipping point.
I want to say upfront that this problem alone won't be as devastating to the global economy as the housing bubble and burst was. But it could end our nice little -- albeit slow -- recovery for a while... and it certainly could affect the rate at which the Fed tightens its monetary policy.
And if any other major economic disaster accompanies this problem -- like, say, a few countries exiting the euro or a full-blown Japanese depression -- this could be the trigger to send the U.S. economy over the cliff.
U.S. Banks Are Going To Extremes To Increase Profits
Many banking institutions have struggled these past several years. I know, it sounds absurd that after all that government money through TARP and other giveaway programs, banks could still be in trouble. But it's precisely because of all this so-called "free money" that they are struggling.
You see, the bottom line for a typical bank is comprised of the margin between how much they spend on short-term financing of their own and how much they receive as interest on long-term loans they make. But with zero-bound interest rates over the past six years, that margin remains next to nothing.
So the banks are getting creative.
Of course, banks are all-too aware of the risks of offering low-credit mortgages. Instead, they are dipping into Americans' second favorite market... auto loans.
Subprime Auto Lending Is On The Rise
If you've ever bought a car, you are likely familiar with the process of getting a car financed. It can be irritating for both the car buyer and car seller alike. And if you've ever bought a car with bad or neutral credit, you know it gets even worse.
Dealers have to "talk" to several banks to see if they can get you "approved." If you're lucky, a few do approve you under certain terms.
In the old days, these loans were fairly straightforward. Terms ranged mostly from 24 to 48 months and the price was set in stone. But those days are largely over for anyone who doesn't have above a 750 credit score.
And unfortunately, that's becoming a larger and larger portion of the American public. According to TransUnion, more than half - 56% -- of Americans have a credit rating that qualifies as "sub-prime." That's up from 48.4% in 2006.
The average credit score at the end of the recession in 2009 was 738. Today, that number is just 709.
Applicants with top credit ratings will see incredible cash-back programs available. However, those with poor credit are more likely to get high interest rates (averaging 10.9% as of the second quarter of this year) and longer terms (averaging 67 months). Meaning, they will owe much more, have a higher expense ratio to their income for their car payments and have to sit on their car for up to seven years at a time.
In addition, the amount of loans made to those with lower credit ratings are on the rise. From April through September of this year, loans to borrowers with "bad" credit (a credit score of less than 620) have totaled $70 billion, according to the Wall Street Journal. Loans to borrowers with a credit rating under 660 (the minimum considered "good" by lenders) has reached $110 billion.
That means new auto loans that rank as subprime are reaching their pre-recession levels. Worse, the amount of total debt appropriated as auto financing is getting exponentially higher:
Already, auto loan balances reached $1 trillion in the most recent quarter -- as you can see above. That's the first time it's taken ten digits to display how much money Americans owe on their cars.
Delinquencies have remained flat... so far. But with terms of up to seven years, there's no doubt they will be on the rise going forward. The last time subprime auto loans were this prevalent, prior to the last recession, delinquencies rose in the following years. They peaked at 1.59%. Today, they stand at less than 1.3%. However, considering the recent growth rate of subprime loans, it could end up even higher this time.
Of course, not all banks that originate auto loans are the same. Some have steered clear of most of this subprime mess. Others have gone overboard. So knowing which ones to avoid and which ones remain safe is crucial to anyone with banking stocks in their portfolio.
On Friday, I'm going to be going show you two of the worst offenders in the subprime auto loan industry. If either of these stocks is in your investment portfolio, watch out -- there may be big trouble on the horizon.
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