Securitizations grow despite lending fearsMark Melin
Subprime Auto Lending series Updated: Jun 26, 2017 @ 09:00
At the beginning of June, the market was spooked by warnings from the auto loan market where overstretched consumers have started to rekindle fears about a debt crisis echoing that of the sub-prime mortgage crisis which began to unfold around a decade ago.
According to the New York Federal Reserve, total auto loans rose to $1.17 trillion at the end of the first quarter of 2017, up almost 70% from the 2010 trough. However, as concerns about the state of the market began to bubble up, lenders began to pull back from the sector.
Securitizations grow despite Subprime Auto Lending fears
At the end of May the Financial Times highlighted data from the Federal Deposit Insurance Corporation, which showed the first sequential drop in car loans outstanding at commercial banks in at least six years during the first quarter. The total slipped $1.6 billion to $440 billion from the fourth quarter of last year to Q1 2017, suggesting that banks had become spooked.
First-quarter earnings reports supported this thesis. Wells Fargo and JPMorgan Chase, the two biggest banks in the sector, saw first-quarter originations drop by double digits. Meanwhile, Capital One, which aggressively added $2 billion to its $5 billion car loan book during the first quarter, has also turned more neutral on the outlook for this asset class.
If auto loan securities deal volumes are anything to go by, it seems as if lenders are not entirely pulling back from the sector. According to the June 23 Asset-Backed Alert newsletter, for the week of June 19 more than $6 billion of Subprime auto lLending securities hit the market, four times more than the $1.4 billion of new transactions priced during the first half of the month. The securities priced encompassed a mix of securities backed by prime loans, sub-prime loans, leases and the dealer-floorplan credits. This transaction volume makes June 19 the busiest week for the sector since the end of March when $6.5 billion of deals priced. That said, supply has been lumpy with May bringing $9.8 billion of deals and April transaction volumes amounting to $6.5 billion.
Still, while transaction volumes may have increased there’s no getting away from the fact that also loan delinquency rates are rising rapidly. According to the New York Federal Reserve, during the final quarter of 2016 auto loan delinquencies of greater than thirty days or more reached $23.27 billion, the highest value since the $23.46 billion registered in Q3 2008. While this figure is only 3.8% of the enlarged $1.2 trillion auto loan market, there’s no denying that this is a worrying trend and it may only be a matter of time before the whole market tips over, especially as lenders start to become concerned about their exposure.
The rising auto loan delinquency rate is nothing for investors to be concerned about – not yet, says a UBS report. Yet stretched households are “one minor hiccup away” from dramatically increasing the subprime default rate and spilling into the general economy, Bloomberg View columnist Danielle Dimartino Booth recently noted on the “What’d You Miss” cable television program, is it time to be worried about subprime auto lending, or is UBS right?
Subprime Auto Lending - A perfect storm
With the new car market softening in Europe – April sales fell to 6.8%, the biggest drop since 2013 – and US manufacturers announcing plans to layoff workers, the market is softening. Nearly 4 million cars coming off lease in 2017 and used car prices are dropping, Booth noted, meaning that subprime borrowers could be holding an increasingly depreciating asset.
Bloomberg’s Conor Sen doesn’t think this nearly the risk that the subprime mortgage market was in 2008, pointing to a shorter loan duration and the rapid paying down of principal as reasons the loans are not a major issue.
UBS Matthew Mish and Stephen Caprio want to determine the nature of the problem in a May 17 article titled “How idiosyncratic are auto loan borrowers (and related credit stress)?”
After looking at the demographics, they conclude the risk is not yet a concern, but that risk hasn’t been priced in to bond yields yet as investors reach for yield.
“While rising auto loan delinquencies are not yet a financial stability concern, they do expose broader consumer stress which will manifest itself in structurally higher consumer (non-mortgage) loan defaults ahead,” they wrote.
To support their thesis, the UBS analysts looked to statistical analysis.
Subprime Auto Lending - Demographics
While subprime auto debt is slightly more skewed towards Millennials, the overall look of the market isn’t that different from the housing market.
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