The Wall Street Journal headline says it all: "Lax Lending Standards Could End Up Fueling Sudden Acceleration in Auto-Loan Delinquencies".
It makes perfect sense and could even be worse than the subprime home lending crisis in terms of its impact on the industry. Because taking out a car loan is pretty rarely a savvy financial move -- and people tend to use them to buy cars they really can't afford -- the industry may be especially vulnerable to an economic slowdown. Irresponsible borrowers are more likely to take out car loans than home loans, and also more likely to walk away from them. And there isn't going to be any federal bailout to help fast food workers keep their Escalades.
Analysts report that delinquencies in car loans rose sharply in late 2007. Consequently, it's important to look at the possible exposure any automotive-related company you invest in has to credit problems. Some companies do their own financing, others don't. A quick look at the risk factors disclosed in the 10-Ks filed with the SEC may provide some clues.
For instance, America's Car-Mart, Inc. (NASDAQ: CRMT) discloses the following:
The Company may have a higher risk of delinquency and default than traditional lenders because it loans money to credit-impaired borrowers.Of course, the company may be managing everything well, and the stock might be a bargain. But this is certainly a major risk factor to consider, especially with the current economic environment -- higher than anticipated losses could result in large writedowns. Also pay attention to how much of a company's income comes from financing.
Substantially all of Car-Mart's automobile contracts involve loans made to individuals with impaired or limited credit histories, or higher debt-to-income ratios than permitted by traditional lenders. Loans made to borrowers who are restricted in their ability to obtain financing from traditional lenders generally entail a higher risk of delinquency, default and repossession, and higher losses than loans made to borrowers with better credit ... If the Company experiences higher losses than anticipated, its financial condition, results of operations and business prospects could be materially and adversely affected.
Be sure to read the risk factors with any company you're considering investing in. True, a lot of it's boilerplate, but most "unforeseen disasters" that send stocks tanking could have been anticipated through a close reading of the risk factors.
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