Moody’s Investors Service warned that risk factors in subprime auto loan securitizations are rising and will lead to higher credit losses. 

In a report published today, the rating agency said these risk factors include gradually weakening loan credit, stiff competition among lenders, which will further weaken credit; and high level of market activity and increased use of prefunding.

“Losses on subprime auto loan portfolios will continue to rise because lenders are making loans to weaker borrowers, as they compete for market share and the operational scale that will help their profitability,” analysts said.

As a result, there has been a decline in the average credit scores for used vehicles loans in Moody's rated deals, to 657 in first-quarter of 2013 from 659 in first-quarter 2012. The average annual percentage rate declined over the same period, to 8.75% from 9.05%.

Moody's said the credit weakening is evident in the performance of subprime loans over the last three years, as measured by 12-month delinquency rates, by vintage, for loans to borrowers with FICO scores below 620.

The report said credit quality is declining as the result of competition from banks and credit unions, which have not traditionally been subprime lenders. This has led to increased lending to weaker-than-prime borrowers. Furthermore, because traditional prime lenders have moved ‘down the credit spectrum’ toward higher-quality subprime borrowers, traditional subprime lenders’ loan credit will weaken even more.

“The increasing competition will further pressure pricing for the traditional lenders, making it harder for them to price for the incremental risk in a shrinking pool of available subprime customers,”  said analysts.

Investors don't seem to be too concerned.

Senior bonds have seen declining spreads at the hands of growing desire for subprime ABS. And there has been an increase in the number of prefunded ABS transactions, in which investors commit to purchase loans before they are made, which Moody's said will further weaken credit quality if issuers use it to expand their origination volume too rapidly.

Meanwhile, Fitch Ratings weighed in on auto lease securitizations, which is accounting for an increasingly large portion of auto-related issuance. In a report published today, it said, “Continued competition from new vehicle sales and increasing wholesale market supply will maintain recent pressure on used vehicle values and have some impact on recoveries for defaulted contracts and auto lease residual realizations.” 

Nevertheless, Fitch said this trend "is a return to more reasonable values from exceptionally strong ones." It expects auto lease ABS to continue outperform expectations in the near term. 

Manheim Consulting’s used vehicle value index hit 119.1 for the month of May. That was the lowest level since February 2010 when it reached 118.1. However, May's reading was higher than any May in prior to 2011, noted Fitch.

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