Subprime Auto Loan Delinquencies Rising To 2019 Levels: A Dive Into Subprime Loans And Securitizations

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Wave of delinquencies not caused by unemployment, but by taking big risks, expecting big profits and getting slapped in the face, like in 2019.

By Wolf Richter for WOLF STREET.

Subprime auto loan delinquencies have rebounded from stimulus-fuelled lows during the pandemic, when borrowers were locked into their auto loans with money they got from stimulus checks and extra unemployment benefits. , and not having to make mortgage payments because they had not entered their mortgages into a forbearance program and not having to pay rent due to eviction bans. Most of this is now over, and the money is gone, and subprime delinquency rates are rising.

Subprime delinquency rate rises, still below 2019 Good Times.

In December, the 60+ day delinquency rate on subprime auto loans increased to 5.7% of total auto loan balances in asset-backed securities (ABS) rated by Fitch Ratings. The record in the 21st century was set in August 2019, Good Times, of 5.9%.

Preferred qualifying car loans are in perfect condition.

Delinquency rates on auto loans rated “prime” are near record lows of a minuscule 0.2%, according to Fitch Ratings. During the height of the Great Recession in January 2009, the prime delinquency rate rose to a still minuscule 0.9%. Prime car loans are a low-risk, low-return business.

Subprime rated auto loans and asset-backed securities (ABS).

Auto loans are classified as subprime for the same reason that many bonds are classified as “junk” (BB+ and below): the borrower has a much higher risk of defaulting on the debt.

Investors buy them because they are paid higher returns to compensate them for taking those higher risks. Subprime auto loans, just like junk bonds, are a high-risk business with potentially high profits and losses.

Subprime used vehicle loans come with interest rates averaging 15% to 20%, depending on how deep you are in the subprime market, according to Experian. Investors are willing to take big risks to earn these kinds of juicy returns.

Much of the subprime lending is done by a group of specialized lenders. Most subprime auto loans are packaged in asset-backed securities (ABS) that investors like bond funds and pension funds buy for their higher yields.

ABS are structured with the equity tranche and the lowest rating tranches taking first losses. As losses mount, the higher rated tranches begin to suffer losses. The highest rated tranche of a subprime auto loan ABS, perhaps rated “AA” (my cheat sheet for corporate bond credit ratings), will only take losses if there is severe damage to the ABS due to breaches.

Tranches with high credit ratings have the lowest yields, and are bought by the most risk-averse investors. Low-rated tranches are bought by venture-backed cowboys. And the bottom tranche is usually retained by the subprime lender that originated the loan – the required skin in the game, which is one reason small specialty lenders can fail.

Subprime lending has been around for decades and is riddled with abuse and scandal. Some subprime loans come with interest rates so high that they practically guarantee that the loans will not pay. Some subprime lenders take big risks in their underwriting practices.

Occasionally, regulators crack down, leading to settlements and fines that subprime lenders see as part of the cost of doing business. And periodically, specialty lenders fail because something went wrong. Risk taking is driven by high yields and the ease with which a vehicle can be repossessed and sold at auction.

In the years leading up to the used car price spike that began in 2020, proceeds from auction sales covered 40-50% of the delinquent loan balance on subprime auto loans (the “recovery index”), according to Fitch Ratings.

But as used vehicle prices skyrocketed from late 2020 to early 2022, the recovery rate skyrocketed. For subprime auto loans, recovery rates exceeded 70% in 2021, well above any previous record, according to Fitch. Used car prices are still very high, but now they are falling. So the recovery rates are declining and will go back to around 40-50%.

Subprime, a small part ($210 billion) of total car loans and leases ($1.52 trillion).

Subprime loans are heavily focused on used vehicles with smaller amounts financed and make up only a small portion of total outstanding auto debt. Here are some basics about the size of subprime auto loans, according to Experian’s third-quarter report (which defines “subprime” as a credit score of 600 or below):

  • Only 13.7% of total outstanding auto loan balances were subprime.
  • Only 15.8% of the total number of loans and leases originated in the third quarter were subprime.
  • Only 5.2% of the number of new vehicle loans originated in the third quarter were high risk.
  • But 22.4% of the number of used vehicle loans originated in the third quarter were high risk.
  • Average used car loan amount originated in the third quarter: $28,506
  • Average new vehicle loan amount originated in the third quarter: $41,665.

Total outstanding auto loans and leases amounted to $1.52 trillion in the third quarter, according to data from the New York Federal Reserve. With 13.7% of outstanding balances being subprime, the total amount of auto debt rated subprime amounts to around $210 billion, most of which is owned by investors who purchased the ABS.

Crimes driven by risk-taking in good times, not unemployment.

Note on the chart near the top of the page: The delinquency rate plummeted from early 2010 through spring 2011, during bad times, during the unemployment crisis, as a result of reduced risks in the new loans.

As you can also see in the chart, as the Federal Reserve continued to clamp down on interest rates beginning in 2011, investors went on a rampage for yield and risk-taking increased across all asset classes, including loans. subprime for cars. This enthusiastic risk-taking caused the subprime mortgage delinquency rate to rise during those years and in August 2019, Good Times, hit a 21st-century record.

It was during these good times in mid-2019 that a group of smaller specialty subprime auto lenders, owned by private equity firms, collapsed into bankruptcy, which I covered at the time.

This August 2019 record, and the specialty lender bankruptcies, came while the job market was hot and unemployment was very low. It happened because these small lenders had been taking big risks for years to get big returns, in a world where returns had become tight.

Despite this high delinquency rate in 2019 and the collapse of some of the smaller lenders, the auto loan business remained profitable for lenders who had managed their risks properly.

So the increase in delinquencies through 2019 was not caused by a jobs crisis, but by increased risk-taking beforehand.

Same thing now: the rise in delinquencies is not caused by any sort of unemployment crisis or whatever (the labor market is historically tight and wages are rising), but by risk-taking between 2020 and 2022.

Risk-taking was further fueled by the mind-boggling rise in used vehicle prices when many of these loans were made, which seduced lenders into thinking they would get very high recovery rates for loans that defaulted. . And they had record recovery rates for a while. But now they are going down.

Despite the increase in delinquency rates back to 2019 Good Times levels, subprime loan losses on ABS that Fitch tracks have remained below those of 2019. In December, the net loss ratio Fitch’s annualized subprime auto loan rate rose to 8.3%, but was still well below December 2018’s 9.7% and December 2019’s 9.4%.

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