'Deep Subprime' Auto Loans Are Becoming the New Normal

A third of all subprime car loans are now being categorized into the ominous-sounding “deep subprime” group. The designation has become progressively more inclusive since America clawed its way out of the recession and now accounts for 32.5 percent of all high-risk loans — up from just 5.1 percent in 2010.

While consumers have fallen behind on most subprime auto loans, the deep classification is responsible for the most serious cases of nonpayment. Delinquencies surpassing 60-day periods have tripled since 2012 and indicate little sign of stabilizing.

“The securitization market has become more heavily weighted towards issuers that we would consider deep subprime,” Morgan Stanley financial strategists wrote in a recent report. “Auto loan fundamental performance, especially within ABS pools, continues to deteriorate.”

Morgan Stanley defines deep subprime borrowers as lenders with FICO scores below 550. The Fair Isaac Corporation doesn’t have a strict categorization for the group, but the general consensus is that anyone with a score below 600 is considered a high risk. That’s a problem as younger buyers typically have lower scores and are less interested in making the kind of financial decisions that might raise their ratings. They’re also less likely to have a steady income or cash reserves, but they’re flooding into the market as comparatively well-off boomers leave it. Someone has to drive the new cars being produced every year, and used vehicles still remain at a premium.

The $3 billion cash-for-clunkers program from 2009 obliterated the cheaper end of the used vehicle market to the detriment of America’s lowest income earners as used vehicles they could have afforded were largely removed from the market. This forced those buyers to scrounge enough money together to buy something more expensive or risk going deeper into debt by taking out a loan they might never be able to afford.

Banks have also become more willing to underwrite riskier auto-loan asset-backed security sales. According to Bloomberg, that translates to investors taking a huge hit, with about $8 trillion of debt globally carrying negative yields, further facilitating higher levels of risk in the securities market. It’s a bad time to be unprofitable. Used car prices are expected to come down soon and new car sales seem to have plateaued.

Subprime consumers won’t care if lenders get screwed. All they want is a used Nissan Altima that won’t require them to take on a massive loan, because the alternative isn’t pretty.