Concerns over subprime auto loans are overblown

Jeffrey Boutin,  Senior Structured Finance Credit Analyst

Boston  - Investors with lingering memories of the financial crisis may be unsettled by recent headlines about rising delinquencies and defaults in subprime auto loans. However, credit trends in subprime auto loan asset-backed securities (ABS) show that the sky is definitely not falling.

This week, Fitch Ratings said prime and subprime auto loan ABS annualized net losses in its index have increased the past three months. However, we believe time-series indices may not provide the most accurate picture, for several reasons.

Increases in subprime auto ABS losses are skewed by the change in mix towards smaller, newer lenders that focus on lower quality borrowers who tend to have higher loss rates. In response to rising delinquencies and defaults, some auto lenders are moving up-market and pushing back on underwriting quality, resulting in better credit quality for some recent ABS securitizations, according to Fitch.

The age or seasoning of the collateral, its unique amortization schedule as well its tenor will all have a major impact on the loss rate each month and increase its variability. . Additionally, strong seasonal trends are evident in November through February that suggest the time leading up to the holidays and after are more constraining on consumer finances. Conversely, spring brings tax refunds checks, which can help reverse the winter loss trends.

Bottom line:  We are seeing some modest deterioration in subprime auto loan performance as it normalizes from the recent financial crisis. However, we believe the amount of credit support inherent in these deals is sufficient to protect them from financial distress.