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Are auto loans a subprime crisis in the making?

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The New York attorney general filed a securities fraud lawsuit against British bank Barclays, accusing the firm of giving an unfair advantage to high-frequency traders in the U.S., while claiming to protect other clients from the HFTs. It's the highest profile case we've seen yet, according to Reuters, as a result of authorities' attempts to make sure dealers aren't ripping off investors in today's largely automated stock markets.

Related: The market is rigged and here’s how individuals can play it

At the same time, regulators are reporting concerns that banks are taking on more risk to pursue profit. A major bank regulator warned Wednesday that competition along with low interest rates and a slowly-growing economy is fueling riskier bank lending.

The Office of the Comptroller of the Currency highlighted two areas specifically: Leveraged loans (described by the Wall Street Journal as high-yielding loans issued to more speculative borrowers) and indirect auto loans (where banks buy loans originated by car dealers). The report calls out "erosion" and "loosening" in underwriting standards, including an easing of lending standards in commercial loans. 

Related: Consumers' surprising reaction to GM's recalls

Chris Whalen, senior managing director in the financial institutions ratings group at Kroll Bond Rating Agency, rates banks and talks to us in the accompanying video about these concerns.

He says subprime auto loans "since the crisis has been the one area of consumer finance that has really grown strongly, even as mortgage finance has declined in relative terms... If you can fog a mirror you can buy a car." (Here's the underbelly of strong auto sales, you might say.) 

We've heard that statement made in retrospect looking at the lending standards during the housing bubble. So is Whalen concerned this could be the next subprime crisis? He's not raising alarm bells at this point.

According to him, to date the default rates on auto loans including subprime has not been that high, meanwhile off-balance sheet finance has been "pretty much prohibited" and there is "less risk being taken by banks overall." 

The OCC meanwhile, said it is worried about growing losses on auto loans, with average losses per vehicle having "risen substantially in the past two years.” According to Experian, the average loss on a defaulted auto loan has risen to $8,500 in the first three months of the year, compared to $7,400 last year.

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Whalen says the trend with banks is indicative of Wall Street's desire to create assets and sell them because banks want to do business. So they've been securitizing auto loans (and also junk bonds) because they aren't securitizing other things anymore.

The bigger issue he points to is that the Fed is pushing investors and banks to take more risk with low rates in a search for yield, but then on the other side the regulators try to move to curb the risk being taken.

The OCC also warns about deposits, and that rising interest rates could affect core deposits at banks in ways that they aren't prepared for. Check out the video to see what Whalen thinks about that.

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