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Subprime car buyers fueling default surge

Editor's Note: The following was written by Yahoo Finance Contributor Milanee Kapadia. You can follow her on Twitter @MilaneeKapadia

Borrowers with shaky credit histories? A rush to fill out paperwork to facilitate loans for them? Bundling pools of those loans and selling them to investors? No, this is not the sub-prime mortgage crisis of 2008. This is the sub-prime auto loan business of 2014. Since 2009, total auto loan securitizations have surged 150 percent, to $17.6 billion last year. And the securities contain loans made to consumers with sub-prime credit.

Now the other shoe may have dropped. Credit reporting service Experian reveals that delinquencies and repossessions are rising, primarily driven by borrowers who would be classified as subprime and deep subprime. While Experian says this uptick is to be expected as the industry sells more vehicles, some are already saying a bubble in subprime auto loans may already be here.

The size of the deals being done are not on the same magnitude as the sub-prime mortgage crisis but according to Mark T. Williams, former bank examiner with the Federal Reserve and Boston University professor, “There’s many similarities between the sub-prime crisis we went through and sub-prime auto lending today. I see it very much a parallel with 2007, that is the Fed reduced interest rates and increased in particular, greater demand to find products that had higher yields, and today that’s what we see. So risk levels are increasing here.”

In this very low interest-rate environment, investors have an appetite for higher yields which typically come from those high risk levels. Just like the mortgage era, banks and private equity firms are lining up to make money available for loans that are then packaged into bonds and sold off in tranches to mutual funds and insurance companies. Williams says this is all happening just six years after the financial crisis. “There’s demand and there’s higher yields in this business so you’re seeing a lot of money from Wall Street flow into this sector. In essence, there’s an increase in securitization and as more of these products are sold in the marketplace, investors are buying this paper. There’s potentialy increased risk,” he says.

Houses and cars are of course, very different. An auto is much easier to repossess, but analysts say auto loans gone sour could become a problem for banks if losses start to increase. Right now Williams is already seeing a trend that is worrisome saying “we are seeing that the 60-day is increasing in non payments, and we are also seeing in this sector that repossesions are increasing. So these two trends themselves suggest that credit risk is increasing.”

And yet more and more money is flowing into this space. Daniel Loeb’s hedge fund Third Point just disclosed a $1.09 billion stake in auto loan financier, Ally Financial (ALLY). And the New York Fed just released a report showing that auto loan debt grew $30 billion in the second quarter. Roughly one in four new auto loans are going to sub-prime borrowers.

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