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Subprime Auto Loans Up, Car Sales Down: Why This Could Be Good for Gold

The latest monthly motor vehicle sales report released on July 3 paints a grim picture for US car sales. Overall June sales dropped by 3% compared to June of last year—the sixth successive month of lower year-over-year sales.

General Motors, Ford, and Fiat Chrysler were among the greatest losers with declines between 4.7% and 7%. Japan’s top sellers fared a little better, with Nissan seeing 2% growth and Toyota a 2.1% gain.

Economists and Street pundits seem to be stumped as to why Americans are so reluctant to buy cars. Hypotheses that are being bounced around range from tight credit markets to costlier car loans, to negative consumer sentiment about the economy.

Sales have fallen off a cliff, compared to 2016, a record year for the auto industry. In the first six months of this year, vehicle sales hit their lowest point since 2014, and consumer traffic at dealerships fell to a five-year low.

Who’s the main culprit here? Many signs point to subprime auto loans…

Subprime Auto Loans: A Wolf in Sheep’s Clothing

As car sales are plunging, the number of risky car loans is rising… and so are incidents of credit fraud. In a UBS survey, one in five borrowers admitted that their applications contained inaccuracies.

However, lenders are actively participating in building this particular Potemkin village. The biggest auto loan provider, Santander, is under investigation in at least 30 states for fraudulent lending practices and recently settled a lawsuit for $25 million.

Rating service Moody’s reported that Santander verified the incomes of just 8% of borrowers whose loans it recently packaged into a $1 billion bond issue. Furthermore, on top of unverified income, 9% of those borrowers had low or no credit scores and no co-signer.

A FICO score below 640 is deemed subprime. At the end of the first quarter, 22.3% of Santander’s retail installment contracts (RICs) showed credit scores under 540. Only 13.8% of borrowers had scores over 640.

Unsurprisingly, 12.8% of these loans were delinquent by the end of the first quarter, handing Santander a net loss of $72 million for the quarter—and further losses are expected.

Loan duration has dramatically risen as well. In the 1990s, a typical auto loan was 48 months. But due to climbing car prices and stagnating incomes, buyers are now asking for longer loan terms to reduce monthly payment amounts.

The fastest-rising class of loans is now 73–84 months, unprecedented for a quickly depreciating asset like a car. 32.1% of new vehicle loans in Q4 2016 were in that group, compared with 29% year over year. Even in the used-car financing segment, those “eternity loans” made up 18% of share.

More traditional banks like Wells Fargo have started to reduce their auto loan business amid deteriorating loan performance. The bank reduced overall loan origination by 30% and curtailed exposure to subprime loans by 27% in the first quarter.

Wells Fargo’s CEO Tim Sloan said auto loans are currently the business with the biggest potential for a “negative credit event.”

However, while major Wall Street banks like Wells Fargo and JPMorgan are more reluctant than last year to make car loans on their own balance sheets, they packaged more loans from finance companies into bonds in Q1 2017 than in last year’s first quarter, and are still among the top underwriters of the securities.

How This Could Be Good for Gold

Thankfully, this is unlikely to become a rerun of the 2008 subprime mortgage collapse.

Compared to the $8.4 trillion mortgage market, the US auto loan sector is small with only $1.1 trillion in loans. It’s also not nearly as leveraged through securitized products—and a car is much easier to repossess than a home.

However, that doesn’t mean a potential implosion of this shaky sector isn’t a threat to the US economy.

It’s quite likely that the exuberant 2016 auto sales figures were inflated by easy-to-get subprime loans with low, long-term payments, enticing buyers to purchase more car than they could afford.

Now that the loans are beginning to deteriorate and subprime buyers are no longer in the market or tapped out, we’re beginning to see the real picture—which is much less rosy than it seemed just a year ago.

Given that the auto sector is a massive part of the economy, this could be an early warning sign of a slowing economy. That, in turn, would be good for the gold price. If the Federal Reserve feels compelled to slow down or even reverse its ramping up of interest rates, gold is poised to rise.

The writing is on the wall: the Atlanta Fed just revised its GDP estimate for the second quarter to 2.7%, from previously 3%.

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