Balances remaining on auto loans have risen by about a third since April 2011, reaching an all-time high of $924.2 billion (575 billion pounds) in August, according to credit reporting bureau Equifax. About a fifth of the loans are subprime.
Banking regulators fear that reckless lending may be at least helping to fuel that growth, and there are early signs that delinquencies are increasing in the sector.
The Consumer Financial Protection Bureau said in September that it is taking steps to oversee auto lenders that have previously been less regulated, and companies like GM Financial and Santander Consumer USA Holdings Inc (>> Santander Consumer USA Holdings Inc) disclosed earlier this year that the Department of Justice is looking into their auto finance practices,
The person familiar with the matter said regulators are asking banks for information about not just loans they made, but financing they have provided to other lenders in the sector, such as credit lines to finance companies. At least one regulatory agency is looking at this area, according to the person, and it was unclear if other agencies were also looking. The Federal Reserve, Office of the Comptroller of the Currency, the Federal Deposit Insurance Corp, and state agencies all regulate U.S. banks.
Getting a handle on this information is difficult for regulators, but is also vital. During the financial crisis, banks often publicly disclosed the total mortgages they held and how many of those were subprime, only to reveal months later that they had tens of billions of additional exposure from secured loans to subprime mortgage finance companies, subprime mortgage bonds that were packaged into new bonds, and so on. These extra exposures turned what seemed like manageable problems into catastrophes that threatened the entire financial system.
LENDING TO FINANCE FIRMS
Banks can have just as many different kinds of exposure to auto loans as they have to mortgages. Wells Fargo & Co, (>> Wells Fargo & Co) for example, is the largest U.S. auto lender, with $50.8 billion outstanding at the end of 2013. About $15 billion of that was subprime. It is also the largest underwriter of bonds backed by subprime auto loans, having sold $3.3 billion of these securities this year, according to industry publication Asset-Backed Alert.
In addition, since 2011 Wells Fargo has extended more than $1.5 billion of credit lines to some of the largest subprime car lenders through its Des Moines, Iowa-based subsidiary Wells Fargo Preferred Capital Inc., according to merger advisory firm Colonnade Advisors LLC.
Other banks, including Capital One Financial Corp (>> Capital One Financial Corp.) and JPMorgan Chase & Co (>> JPMorgan Chase & Co.) are also players in the business of lending to auto finance companies, according to Colonnade. Wells Fargo declined to comment. Chase and Capital One did not immediately comment.
"Banks are making a lot of money off these (auto) loans in many different ways," said Ira Rheingold, executive director of the National Association of Consumer Advocates.
To be sure, these types of exposures are relatively small for a bank like Wells Fargo, which has $1.5 trillion of assets, a net worth of about $180 billion as measured by equity, and a market value of about $264 billion.
Of course, car loans are smaller than home loans – there is about nine times as much mortgage debt outstanding in the United States as auto debt. The loans are also shorter-lived than mortgages, meaning borrowers pay more off every year. And repossessing the collateral is much easier than for a home loan.
Few analysts currently fear a subprime auto meltdown on par with the mortgage crisis. If auto finance companies that specialise in subprime loans fail in an economic downturn, they may not present much of a wider danger to the financial system.
"The subprime auto sector appears too small to present a systemic risk," Bank of America Merrill Lynch economist Michael Hanson wrote in an October report. "It does not appear to be in bubble territory, but bears watching."
And while there are growing concerns about the world economy, which has been reflected in recent declines in U.S. and global stock markets, the U.S. economy has been increasingly buoyant, with the jobless rate sliding below 6 percent and new auto sales strong.
It is also too early to tell what regulators will find, and there is no indication of any wrongdoing by the banks.
Wells Fargo executives have downplayed the risks of the bank's own auto loan exposure. Finance chief John Shrewsberry said in July that the credit scores and other measures of the health of its consumer portfolio of auto loans "has improved not only over the last 5 years, but improved meaningfully from pre-crisis levels."
But auto loans can still be risky, and are showing signs of stress. The share of borrowers who are 60 days behind on their auto loan payments rose 7 percent in the second quarter from a year earlier, and the repossession rate rose over 70 percent in the same period, according to Experian Automotive, though both rates are still near historical lows. Used car prices fell for the fifth consecutive month in October, which hurts the amount of money banks can get from selling cars that they repossess.
"Every metric is moving in the wrong direction if you're worried about risk, though it's not going so fast that it's alarming," said Colonnade Managing Director Christopher Gillock.
Unlike property, cars tend to depreciate in value over time, a factor that can add to a bank's losses for every loan that goes bad. If the economy slows down and lenders find themselves with large numbers of bad car loans, that selling pressure could hurt the value of the collateral for loans. In a slow economy, auto dealers often slash prices for new cars, hurting used car values even more.
The independent auto finance companies that banks are funding, including Exeter Finance Corp and Westlake Financial Services Inc, tend to cater heavily to subprime borrowers. Nearly 75 percent of auto loans that finance companies made in the second quarter went to subprime borrowers compared with 18.1 percent for banks, according to Experian Automotive.
Wells Fargo has already experienced headaches from lending money to auto finance companies. In April, New York Superintendent of Financial Services Benjamin Lawsky brought a case against auto finance company Condor Capital, which Lawsky accused of keeping millions of dollars of customer rebates for itself.
Wells had extended Condor $261 million of loans under a credit facility around the time Lawsky had moved to shut the company down. Wells sought in court to reclaim that money, but the funds have been tied up for six months while the receiver searches for a lender to refinance or purchase Condor’s loan portfolio. Wells Fargo has recovered some money, and its current exposure is around $200 million.
(Reporting by Peter Rudegeair in New York; Editing by Dan Wilchins and Martin Howell)
By Peter Rudegeair