Subprime Loans – Rewards & Risks

Harley-Davidson Motorcycles has been viewed with high regard by many in the boating trades as a company to emulate. Its history includes a revival after significant product improvements, sustained growth through careful management of production volume, and culturing of a passionate devotion to the brand by owners and many owner wannabes.
It came as a surprise then this spring when stories about Harley were circulating in the financial press about troubles it was having with loans to certain customers. It seems that the firm’s financial service division was extending loans to “subprime” borrowers, some of whom were subsequently unable to maintain payments. That meant dealers had to take back some cycles and, since Harley’s finance division is a contributor to company profits, its stock price took a hit. Some analysts wondered that if things are so rosy at Harley, why do they need to push bikes to fringe credit borrowers?
Other analysts took an opposing view. News accounts said that 10 to 15 percent of Harley’s sales last year were financed with subprime loans. Since then, loan losses reported have increased from about 1.3 to 1.4 percent. Tim Conder, an analyst with A.G. Edwards & Sons who follows the recreation business, including boating, compares this to 4 percent losses for all loans made to buy motorcycles and all-terrain vehicles. He seems to suggest that Harley Finance’s acceptance of the extra risk is worth the resulting sales gain. Of course, time will tell if the risk ebbs or flows.
It’s dangerous to compare the boating market to other recreations, but the temptation is great. HD motorcycles can retail for $25,000, a figure that would encompass many types of small recreational boats. If financing could be extended to credit challenged consumers considering boats in this price range and, say, 5 percent more qualified, it might translate to 15,000 plus sales (assuming 350,000 small boat sales annually).
Boating has eyed growing sales beyond traditional buyers who are mostly middle class-and-up earners by encouraging lenders to extend financing to those below that income level and with lower credit scores. The experience that Harley had, however, suggests asking if pushing product and loans to less qualified borrowers is good for the boating or finance industries.
Repossessed product impacts demand and new and pre-owned retail pricing. Hassles result for dealers and manufacturers. Barriers might be raised for consumer borrowers in the form of tightened lending standards — increased interest rates and shortened terms — which will increase the monthly cost of ownership. Lenders’ ability to “pool” boat loans then sell securities to keep new funds flowing might be reduced. Owners of repossessed boats certainly won’t be happy.
Perception counts, too. Media covering subprime troubles in the real estate market have begun calling agents “hustlers” and lenders “predators.” A year earlier they were seen as “white knights” helping lower income families realize the dream of home ownership.
There are ways to reduce the lending risk within the subprime sector. Lenders can decide “how low they will go” in terms of credit score acceptance. Generally, the higher the credit score, the lower the lending risk. A top credit score for a boat buyer would be above 800 while an average credit number would be in the mid-700s. The average U.S. credit score is 675. Going below these numbers opens up more potential customers but there is related data that indicates more loans will become delinquent (with installments not paid on time) and more of those will default.
A recent Standard & Poor’s report on car loans that had been securitized indicated prime loans have cumulative losses of less than 3 percent with credit scores of 680 or more; non-prime pools have net losses of between 3.1 percent and 7.5 percent with credit scores of between 620 and 680; and subprime securities have net losses above 7.5 percent with borrowers scoring less than 620. S&P also sees a link in higher defaults for longer-term loans and those that carry higher interest rates, as do most subprime loans.
Risk and reward are balanced constantly by the smallest entrepreneur and savviest finance executives. To grow boating, acceptance of a bit more lending risk may be a worthwhile gamble – or a shot in the foot.

Leave a Reply

Your email address will not be published. Required fields are marked *