When asset-backed investors hear, “similar to 2005-2007,” it’s a history lesson that sets off alarm bells.
Despite mounting losses, however, credit ratings agencies maintain a steady-but-cautious outlook for subprime auto loan securitization portfolio performance in 2017.
Fitch Ratings expects a “stable” but “weakening” environment for the subprime market, which comprises nearly 40% of the outstanding $98.3 billion market of auto ABS, prime and non-prime, that it rates.
Many established players, such as Santander Consumer USA and GM Financial’s Americredit, have portfolios that will perform within expected parameters. But many newer and smaller lenders are “to experience rising losses in 2017, particularly relative to the two large Fitch-rated platforms” from Santander and Americredit, and has forced the agency to raise the forecasted range of annualized net losses to the 9%-12% range – for which Fitch evoked the pre-crisis comparisons.
Driving the trend are both declining used-car prices, which hurt asset recovery rates, and the spiking losses occurring in recent-vintage securitizations from 2015, which are “extrapolating” to 14-15% - compared to just 11-13% from 2012-2014 deals. Fitch has been reported a spike in losses since the summer, when ANLs surged to 7.93% in July, a 28% hike from year-over-year comparisons.
“This trend will continue for the 2015-2016 vintages in 2017,” the report noted.
“The much smaller platforms, those names tend to be the ones that are more aggressive and target the weakest part of the subprime spectrum,” said Fitch managing director John Bella.
Despite the deterioration in performance, it’s still possible to raise money in the securitization market, even for newcomers. In December, a 167-store regional buy here/pay here lender owned by private equity firm Altamont Partners – J.R. Byrider – came to market with a first-time, $109 million ABS transaction backed by bottom-feeder loans to high-risk borrowers. Those buyers had credit scores ranging from 450 to 600 – and no credit score for nearly 24% of the loans in the pool.
Kroll Bond Rating Agency expects a whopping 31.5% and 33.5% of loans backing CarNow Auto Receivables Trust 2016-1 to go bad, and it required 66% credit enhancement to assign a preliminary ‘AA’ rating to the deal.
To put that in perspective, American Honda Finance only has to offer initial hard-target credit enhancement of 2.75% in order to triple-A ratings on the prime loans it securitizes via its ns originated by American Honda Finance for its Honda Owner Trust platform.
Smaller lenders are bottom-feeders by necessity. Christopher Gillock, a managing director with Chicago-based consultancy Collanade Advisors, said these players usually have to develop market share with indirect auto loan programs with dealers through an “adverse selection” process: dealers will only throw them loan applications from the rejection pile of more-established lenders.
Bond rating agency DBRS reports also believes quality metrics will continue to deteriorate for subprime lenders in 2017, but would only result in “higher, yet manageable increases in their funding costs” of deals, with investors demanding higher liquidity premiums as asset quality deteriorates beyond expectations.
The capital and liquidity for subprime companies itself has “somewhat weakened, in particular within the subprime segment given their risk profile, where DBRS will continue to evaluate capital ratios for signs of more significant weakening.”
“Although much has been written about a possible subprime auto bubble and the potential implications should such an asset bubble ‘burst’,” the agency report stated, “the risk in the growth of subprime auto lending is not yet a concern.”
Regulatory concerns did played a role in the curtailing of origination volumes in 2016 for Santander and Americredit, What may be of concern to some smaller subprime players in 2017 will be the compliance requirements for the Consumer Financial Protection Bureau.
The CFPB took over supervisory duties for 34 of the largest non-bank auto lenders in 2015, comprising 90% of the loan origination volume in subprime, and are expected to intensify on-site reviews of lenders’ practices.
While the bureau’s future role under the scrutiny of a potentially hostile Trump administration may be questionable, its examiners will be closely monitoring subprime lenders in the areas of underwriting and debt collection practices – which will be noted by investors already growing wary of the profit challenges from an apparent oversaturated field of lenders.
No lender may be too small for the CFPB’s microscope: last January, the CFPB extracted $700,000 in retribution penalties against a small tote-the-note chain based in Colorado – Herbies Auto Sales – for alleged abusive financing schemes.
“Everybody is very focused on complying with the law. That goes for the biggest guys to the smallest guys,” said Chris D’Onofrio, a DBRS senior vice president tracking subprime auto securitizations. “Whether the CFPB has made inquiry not, if they have not come calling, they will.”
The picture is much different for prime auto loan securitization. Here lenders began tightening underwriting criteria in 2016 after several years of loosening standarss. Moody’s Investors Service expects to stabilization top continue in 2017. However it sees flat performance for near-prime pools in weighted-average FICO scores, lengthier loan terms and a higher percentage of riskier used car loans being financed as opposed to new-car financing.
