October 6, 2019

Sub-Prime Lending is Back: Here We Go Again?

by Hal Gershowitz

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Monaco, Monte Carlo — We’re diverting our attention this week from President Trump’s contretemps to focus on another issue we’ve been tracking—the aggressive return to sub-prime lending. Actually “sub-prime” still has a nasty connotation so, today, lenders refer to these higher risk loans as “non-prime.” For some reason, that seems to make them more comfortable.

Credit scoring agencies such as Experian generally consider borrowers with FICO scores below 620 to be subprime and higher risk to lenders.

High-risk borrowers, however, are finding a growing market eager to lend them the money they need. These lenders to higher-risk borrowers are not confined to the housing market either. Higher risk loans are growing in quantity in auto financing and corporate financing as well.

First, let’s take a look at housing. The Government National Mortgage Association (Ginnie Mae), which backs FHA and VA loans is now the largest sub-prime mortgage guarantor in the world. Unlike Fannie Mae and Freddie Mac, Ginnie Mae really does commit the full faith and credit of the United States of America behind the mortgages it guarantees. That is what Ginnie Mae was created to do in order to make home loans available to a generally underserved sector of the mortgage marketplace, such as first-time borrowers and lower-income borrowers. That’s a good thing. Nonetheless, Ginnie Mae-guaranteed loans today entail more risk than at any time since the Global Financial Crisis of 2008.  According to industry data, it is pretty common today to see debt-to-income ratios of Ginnie Mae borrowers hovering above 45% (meaning Ginnie Mae is guaranteeing loans of borrowers who already are carrying a lot of debt). By contrast, just five years ago, debt to income ratio’s hovered closer to 30%. Down payment requirements of less than 10% are also reported to be quite common.

With Ginnie Mae borrower credit scores frequently averaging well under 700 and many in the low 600’s and some in the 500’s, industry observers worry that the next economic downturn could see a substantial repeat of mortgage defaults with the taxpayer holding the bag.  

The sub-prime or non-prime lending market isn’t confined to housing either. Another sector being closely watched is the auto-loan sector.

The Federal Reserve Bank of New York recently reported that more Americans than ever — in excess of 7 million — were at least three months behind on their car payments. On a percentage basis, the delinquency rate is the highest since 2012, even though lending has now shifted toward more creditworthy borrowers. The share considered “subprime” who are behind on their payments is the highest since mid-2010.

Then there is the finance sector that lends to companies that are already highly leveraged. This sector of the loan market consists of an estimated $1.3 trillion of rather risky corporate loans.

Many international financial observers have, for the past year, been warning that the leveraged loan sector was beginning to look a lot like the financial crisis of a decade ago.

 Among those who have taken note of the increases in debt being incurred by companies that are already over-leveraged is The Bank of England, Australia’s central bank, the International Monetary Fund and members of the US Federal Reserve.

These institutions have warned that the “global leveraged loan market was larger than – and was growing as quickly as – the US sub-prime mortgage market had been in 2006”. These banks worry that underwriting standards are slipping and that risky corporate debt has become too easy to obtain.

A legitimate question is whether a bubble other than in the housing market could trigger a market panic.

Our readers will recall that in the lead-up to the 2008 financial crisis, banks liberally handed out mortgages to customers with weak or no credit histories who, subsequently, ended up defaulting when the economy weakened. Today, a repeat of loose lending could endanger the economies of many nations. Rather than making high-risk loans to homeowners, many banks are reportedly making leveraged loans to already highly indebted companies, often with few loan covenants designed to protect the lender. That is, these corporate loans come with fewer strings attached and, therefore, increase the risk for lenders.

 These higher-risk corporate loans are sold and packaged as collateralized loan obligations or CLEO’s (sound familiar) and, as such, are bundled with fewer incentives to impose strict terms.

According to Amir Amel-Zadeh, an associate professor at the University of Oxford’s Saïd Business School, investors in leveraged loans, loan mutual funds, and CLOs could face higher losses than investors in the same products during the 2008 global financial crisis because of lax lending standards, an increase in covenant-lite loans and higher levels of corporate indebtedness than 10 years ago.

As they like to say here in Monaco, “Plus ca change plus c’est la meme chose.” The more things change, the more they remain the same.

All comments regarding these essays, whether they express agreement, disagreement, or an alternate view, are appreciated and welcome. Comments that do not pertain to the subject of the essay or which are ad hominem references to other commenters are not acceptable and will be deleted.

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3 responses to “Sub-Prime Lending is Back: Here We Go Again?”

  1. Perry Green says:

    As long as the agencies of the Federal Government guarantee
    loans with little or no impunity of their actions we will see the
    greed and recklessness of these institutions.

    With the high cost of government exceeding inflation percentage,be it local,State, or Federal the squeeze on wages

    Sad commentary on the responsibility that the Federal
    government bears with guarantees and not so long ago
    we experienced a near total meltdown of the economy
    by the same policy.

    No institution should be required to back unworthy investments unless in the National Interest.

    These institutions Such as Ginnie Mae are the result of great
    lobbyists capitalizing on the system. After viewing CSPAN
    and Washington Reports viewing hearings I have no confidence that the House Members will resolve any crisis
    looming except their obsession of impeachment of the POTUS.

    Must agree the ‘Clock is ticking”‘.

  2. susan duman says:

    I find myself in a philosophical phase this morning. I love history. I love psychology and human behavior. Therefore, I can only say that you will be remembered for an inexhaustible need to understand and communicate. I am ever grateful.
    That being said, I will spend the next few hours watching The Chicago Bears play football in London. I will just sit by and enjoy.

  3. Robert borns says:

    Monaco doesn’t change for sure. I first spent time there in 1970 at the hotel de Paris and when there last a few years ago the hotel, the yachts in the harbor, the changing of the guard, the casino, the museum of the sea and the people who live there to avoid taxes haven’t changed a bit. What a beautiful place in this world. Cares of the world don’t exist there.

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