Subprime Auto Loan Crisis Chronometer

Crisis /krīsis/: A turning point that results in a battle over loss allocation.

Will there be a crisis? Are we near one?

Practices and factors similar to those contributing to the subprime mortgage meltdown are now impacting subprime auto lending and related ABS. The gauges reflect our take on how they are impacting risks for lenders and investors.

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The Subprime Auto Loan Crisis Chronometer shows the risk of battles over loss allocation.
Mar 2019
Lending Practices and Factors i
Subprime originations have trended down but securitization volume continues to increase. Subprime delinquencies in the secondary market are on the rise and have surpassed peak levels. Risky practices are exposing specific lenders and their investors to losses, as evidenced by the closure of a number of smaller subprime auto lenders earlier this year.
ABS Practices and Factors i
Credit enhancements such as excess spread, overcollateralization and subordination have increased in new deals and continue to create a buffer from riskiest lending practices. Investors have not yet felt the sting of riskiest practices.
Auto Market Risks i
New and used vehicle prices are at all-time highs, but sales incentives and high supply of off-lease vehicles are accelerating depreciation and driving up negative equity on trade-ins. Advances in technology will likely accelerate depreciation further.

If you want to know the truth, no one can really predict the future of any market by themselves; everyone is limited by data and perceptions. Without shared knowledge and experience, the future remains a puzzle only time can solve. Where there is limited information, J.D. Salinger’s prediction is inevitable: “the fact is always obvious much too late.”

But in subprime auto ABS, we don’t have to succumb to Salinger’s fatalism. By taking the pulse of all types of industry participants – lenders, servicers, investors, trustees and others – Credit Chronometer’s survey will contribute to a more informed, broader perspective in the industry to help avoid any agonizing surprises.

Certainty Leads to Risk

As I recently discussed with Structured Credit Investor, investor demand for junior notes remains strong, and though we can’t know investors’ views on the economic outlook, the demand implies a high level of comfort – regardless of the economy – with the structure of deals and sufficiency of credit enhancements. Creditworthiness of borrowers has been on the rise, but loan terms are longer and credit extensions are becoming more prevalent. What are lenders, servicers, trustees and others seeing or anticipating that may cause investors to adjust their expectations?

Uncertainty Compels Us to Find Answers

As I mentioned in the recent global report on subprime lending issued by Blueshift Research, auto loans appear to be the riskiest of the subprime segments and has the weakest outlook versus mortgages and personal loans. Most concerns are due to unknowns – are borrowers overextended; will there be an economic downturn; what will be the effect of interest rate changes and automotive tariffs on auto prices and demand?

The findings in this week’s report by the New York Fed on 2018 fourth quarter household debt and credit raises further questions for the future of subprime auto. As I discussed with Global Capital, auto loan originations reached their highest level in recorded history, generating more subprime borrowers than ever before, yet subprime borrowers are falling behind. Why are subprime loan delinquencies increasing despite the strong economy, including low unemployment? It may be the effect of underwriting standards, but it may also be evidence that the benefits of the strong economy are not trickling down to a segment of the population. It’s also possible the beginning signs of consumers’ changing relationship with vehicle – a future less dependent on vehicle ownership may be present today.

Lenders and issuers may be expecting strong pull-through demand to continue in securitizations, but that could change if investor-side outlook takes on a less than rosy tint. As subprime performance goes downhill, risk spreads upward to private equity firms and outward to warehouse lenders and securitization trusts. This could result in recalculating the balance among credit quality, credit enhancements and credit ratings.

The time is right for a 360-degree view in the industry to gauge industry sentiment as to whether credit enhancements will be sufficient to protect investors in a downturn and other factors that could have either a positive or negative affect on ABS performance.

You can take the survey here in about as much time as it took to read this post.

Looking Ahead

We expect to publish a copy of the report with our findings by spring. Anyone who completes the survey will receive a complimentary copy. We’re looking forward to proving Salinger wrong and providing the information that will enable all to make better decisions, before it’s too late.

Nicole Serratore, an Attorney in the Insolvency, Creditors’ Rights & Financial Products Practice Group of Davis & Gilbert, contributed to this post.