Subprime auto, consumer lending draw ABS investor scrutiny
Concerns grow over sub-investment grade 2021 and early 2022 deal vintages
ABS market participants are placing increasing scrutiny on credit risk in the subprime auto and consumer lending ABS space amid signs of increasing delinquencies, even as low unemployment continues to provide encouragement.
At the Structured Finance Association’s annual conference in Las Vegas this week, several panellists highlighted the low unemployment rate in the US as a positive as they keep their eyes on US macroeconomic data. Yet, several investors at the conference expressed their concern to GlobalCapital that there are risks in the subprime auto and consumer lending ABS sectors.
This is particularly relevant for deals printed in 2021 and early 2022, when the economy was recovering, the lenders were competing for origination in a busy market and underwriting standards may have been relaxed.
“I have seen an auto loan approved within three seconds just looking at a FICO score, without a proof of income,” an investor said.
While the 30 to 60 day delinquencies for non-prime borrowers are returning to 2019 levels, delinquencies of 60 days or more hit highest levels since at least 2006, according to KBRA data presented during a panel about the state of the consumer at SF Vegas. After a strong performance following government stimulus payments during the pandemic, some attribute a recent rise in delinquencies in the subprime auto space to a simply a normalisation of credit conditions.
But there are some signs that this so-called normalisation is worse than previously expected.
Standard & Poor’s has put several subprime auto deals on negative watch in recent months, including transactions from American Credit Acceptance, Exeter and United Auto Credit. On December 22, as it placed the class ‘E’ notes of four Exeter Automobiles Receivables Trust deals from 2022 on credit watch “with negative implications“, the rating agency highlighted a “worse than expected performance and decreases in each transaction’s overcollateralisation amounts”.
Also at SF Vegas, panellist Jack Ervasti of KKR pointed out that some issuers had underwritten thin credit files to stretch for volume or yield.
“A lot of the performance trends that we have seen over the last six to 12 months have been underwriting driven; some of them have been inflationary driven,” Ervasti said. “I think part of our jobs as investors is to be able to dig through that underlying data and figure out which segments are more weighted towards the credit versus the others.”
The questions surrounding the underwriting standards of different issuers are leading investors to stick with more familiar names, especially among bonds that have exposure to subprime borrowers. This also driving spread disparity between programmatic and non-programmatic issuers in the ABS market.
One investor told GlobalCapital that they are today spending a lot more time understanding the structure of deals before buying.
Personal loans are facing the same challenges as subprime auto, as credit boxes widened during 2021 and early 2022.
Joanne Gaskin, vice president at FICO, highlighted on a panel at SF Vegas that there is lack of consistency of reporting when it comes to buy now pay later (BNPL) transactions. Yet “BNPL is such a small percentage of the overall standings, we don’t think it is going to negatively impact overall the state of the consumer,” she said.
“But it is certainly a riskier venture.”
In addition to underlying credit risk, investors in sectors such as consumer lending and subprime auto are also prone to sharp swings in the market headline risk driven by negative macro data about the US consumer.
“Prime consumers are doing fine, but there is certainly headline risk for investment managers when it comes to some sectors,” an ABS banker told GlobalCapital.
Analysts said some issuers have already started to issue fewer double-B and triple-B rated tranches because of a decline in investor demand on the back of both headline and credit risk.
Ultimately, although the wider spreads may already be pricing in credit risks, the potential for sticky inflation — and its likely implications for the broader fixed income market — is still a potential obstacle.
”This is a very good time for debt investors,” said the banker said. ”Yields are high and, even with some market volatility, their chances of returns will still be better than 2022, when rates moved too quickly.
“But if the inflation numbers cannot be tamed, and investors start thinking that we don’t actually have a solution [for inflation], then things might start looking different.”