The next bubble is bursting.

There’s more than a trillion dollars riding on it.

And the first leg down has already sent shares of some companies directly affected by it down as much as 60% in the last few months.

The next leg down isn’t far away either.

The First Shoes Are Dropping

Yesterday we talked about advertising and how to “follow the money” in advertising.

Here’s one of the biggest advertising booms.

About 50 million folks bought a new car in the last three years and tens of millions of used cars.

About 70% of all new car purchases involve a financing agreement of some kind.

And in 2016, marketing database companies know pretty much everyone who has a loan and and inundates them with refinancing offers.

Maybe you’ve seen the “Save $128 Per Month” on car payments or something like that.

The fine print shows most are just extending a loan with 43 payments left back out to 60 months to get the “savings.”

Our focus is on the advertising volumes and how it signals strength.

In this case, that’s where the problem -- and the opportunity -- comes in.

Right now there’s a major change quietly occurring in the auto loan market and investors are just starting to realize it too.

This is all something we talked for years now starting with our question, When Will The Auto Lending Bubble Burst?:

Today the average duration of an auto loan is 66 months. That’s longer than it ever has in U.S. history. The last time auto sales peaked in 2001 the average duration was 46 months.

Not long ago a 60 month car loan was the longest you could get. And the 60-month deal was largely reserved for brand new cars. The average used car loans were a year or two shorter.

A lot has changed. Today the fastest growing duration loan is seven years or 84 months. This duration now make up 19.5% of all new car loans.

The rise of long duration loans helps current sales by pushing down monthly payments for a new car. But it also brings a lot of people who would wait to buy a new car forward in the sales cycle by a few years. So when the hangover does come, you can bet it will be a big one.

The final factor driving sales and closely related to duration is the credit quality of the borrower.

Today the fastest growing segment of borrowers is classified as “Deep Subprime.”

These are consumers with a FICO credit score below 620. The estimated average delinquency rate for these borrowers is 40%.

Deep Subprime borrowers now make up 12% of all auto loans.

All the warning signs are there. They’ve been there for awhile. It was only a matter of time until it burst.

Now is that time.

A Trend Is A Trend Until The End

The auto lending bubble is in the first stages of implosion.

It’s bad now, but it’s going to get worse.

This chart shows exactly why it will get worse.

Notice the different FICO credit score quality and how much more of new auto loans they make up:


That chart shows it all.

Auto lending standards are basically back to where they were in 2005 and 2006. federal reserve bank of new york consumer credit panel

You’re looking at one third of all loans to subprime borrowers. Well over half of those are going to deep subprime borrowers.

Those are risky loans and could, and probably will, eventually blow a hundred billion hole in the banking system.

Just a write-off of 5% to 10% of these loan values quickly multiplies into tens of billions of dollars.

The reason? Because there are now more than $1 trillion in auto loans outstanding:

$1 trillion outstanding auto loans

That’s an all-time record for total auto loans.

Naturally, it’s an all-time record for subprime and deep subprime auto loans too.

It’s musical chairs. It’s fun while the music’s playing, but the music must and will stop eventually.

Right now the music is getting closer to stopping than it has since 2008 and it’s taking a lot of companies down with it.

Two stocks provide excellent examples of the first stage of this bust.

One pure-play on the lending market is Consumer Portfolio Services (CPSS).

CPSS is a consumer finance company focused mainly on the auto lending market. At last report it had just over $1.9 billion of auto loans on it’s books.

Now, CPSS is a small company. Really small. It’s current market cap is $118 million.

So comparing $1.9 billion in loans and $118 million market cap and it’s easy to see it wouldn’t take much of a downturn in the value of these loans to completely wipe out the company.

The market has finally realized this and is pricing in a lot more risk into the stock (a.k.a. sold it off):


Of course, CPSS isn’t alone. A lot of companies chased the auto loan boom aggressively.

Another leading auto lender is Santander Consumer USA (SC), the U.S. arm of the global giant Banco Santander (SAN).

One of the ways Santander gained so much market share over the last few years was to provide loans to some of the riskiest borrowers around.

The market has finally woken up to it’s sizeable stake in the auto lending market too:

sizeable auto loan industry

The busting of the auto lending bubble is inevitable.

The first stage has been relatively slow and gentle.

Aside from the examples above -- which have the most direct exposure to auto loans, especially low quality auto loans -- there will be a lot more pain before this is over.

But here’s where it gets really bad.

The auto lenders are getting hammered now. But it’s actually not bad at all...yet.

The chart below tracks how many auto loans are officially delinquent:

default auto loans

The chart shows delinquencies are at record lows.

So we’re left wondering: If the auto loan bubble is deflating during record-level good times for on-time payments, what will happen when those delinquency rates start to move up?

The answer is not good, even in the best-case scenario.

Again, the auto loan bubble is not the housing bubble.
The housing bubble was based off $13 trillion in mortgages. The auto loan is just $1 trillion. But that’s enough to do a lot of damage to a lot of banks and have reverberations throughout all sectors connected to it.

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