Subprime Auto Defaults Heading to 2008 Financial Crisis Levels, Portfolio Managers Warn

Used cars are displayed at a dealership on June 10, 2022 in New York City. Spencer Platt/Getty Images

Consumers with lower credit scores are falling behind on their auto loans at a rapid pace and will likely reach levels not seen since the 2008 financial crisis and recession, said an investment group in a recent note.

Inflation and higher interest rates have been taking chunks out of Americans’ paychecks in recent months, but it is now “very apparent to us that it is negatively affecting subprime borrowers (who tend to have lower credit scores and lower incomes) more harshly than others,” portfolio managers Paul Van Lingen and Ara Balabanian, of fixed-income asset manager Bramshill Investments, wrote to clients in a note, according to multiple news reports.

“All else being equal and continuing the current path, we are assuming defaults and recoveries will continue to deteriorate more toward levels not seen since the GFC,” they added, referring to the 2007–08 Great Financial Crisis.

They noted that in March, delinquencies on subprime auto loans that are at least 60 days late rose 9 percent for borrowers who have credit scores of 550 and under. Before the COVID-19 pandemic, in March 2019, the rate was 7 percent, they said.

Subprime loans generally have high interest rates and are generally made to people with low credit scores, have low income, or have little credit history. Generally, those individuals often do not qualify for conventional loans.

In the coming months, a larger share of American consumers will “run out of excess savings,” meaning there will be more delinquencies and missing payments on subprime auto loans, said the Bramshill analysts.

Data from S&P Global as of March shows that the number of payments on subprime auto loans that were at least 60 days late rose to more than 6 percent last December, according to a graph published by Axios.

And, meanwhile, data posted by Edmunds, a car-shopping website, the average negative equity value of auto trade-ins was up 29 percent to $5,341 in the fourth quarter of 2022. Over the same period, the number of vehicle sales that involved a trade-in with negative equity also increased by some 17 percent, the data show.

In recent months, the Federal Reserve has rapidly increased interest rates amid elevated inflation, sparking warnings from a number of top investors. Earlier in May, the Fed rose rates by a quarter of a point to the highest level in about 16 years.

But Fed Chairman Jerome Powell signaled that it’s not clear if the central bank will suspend its spree of rate hikes in the coming days. Some have expressed worry that the increases will put more pressure on small-to-medium-sized banks such as those that collapsed since March.

Bond trader Jeffrey Gundlach said last week that he is getting more bearish, including on riskier portions of credit markets. He also cautioned that the banking crisis isn’t over until rates get slashed by the central bank.

“It just seems to me that deposits are going to keep drifting out,” Gundlach told CNBC. “I don’t think this is the last chapter in this regional banking problem.”