The Other Shoe Drops: Prime Auto Loan Losses Surge As Recoveries Tumble

Tyler Durden's picture

When we looked at subprime auto delinquencies most recently, we found some troubling trends: first, in February, we showed that 61+ day delinquencies in General Motors' subprime securitization book would support a rather bleak thesis for future auto sales, and specifically the demand side of the equation, with January 2017 delinquency rates soaring to the highest levels since late 2009/early 2010. 


Ironically, this hasn't stopped lenders from providing financing, and according to Morgan Stanley since 2010, the share of Subprime Auto ABS origination that has come from deep subprime deals has increased from 5.1% to 32.5%, suggesting that yield-starved buyside will put "other people's money" into anything as long as it provides a slightly higher yield.


Meanwhile, the subprime shock has already impacted the broader market, observed with the latest monthly auto sales data which declined four month in a row heading into May. An even bleaker picture of the subprime market emerged a month later when looking at the latest securitization analysis from Morgan Stanley which revealed that 60+ day delinquencies at 266 subprime auto ABS deals were surging - despite low unemployment, high consumer confidence and debt-to-income ratios at 30-year lows - back to 'great recession' levels. Meanwhile, loss severities were also shooting higher just as used car prices were sliding.


Used Car Prices

In part, this tied in with the overnight look at the "flood of off-lease vehicles", according to which by the end of 2019, an estimated 12 million low-mileage vehicles are coming off leases inked during a 2014-2016 spurt in new auto sales, which is set to put even more pressure on used (and new) car prices for the foreseeable future.

As Reuters noted, a computer search for available used vehicles within 150 miles of Reel revealed an eye-popping figure: 668 Escapes. That's enough to put more than 40 percent of the inhabitants of this small northeastern Ohio town, population 1,600, into the popular crossover. A search for the Chevrolet Equinox, a comparable crossover, showed 461 available.

"The automakers have flooded the market," said Reel, owner of Reel’s Auto in Orwell, Ohio, about 40 miles east of Cleveland.

The above trends validate a recent bearish Morgan Stanley analysis, which forecast that the plunge in used car prices is just getting started, and in a bear case, the bank sees used car prices dropping by up to 50% over the next 5 years.


* * *

However, in an even more troubling development for US consumers, it now appears that the other shoe for the US auto market has finally also dropped, and according to analyses by both Morgan Stanley and S&P, losses on prime auto loans are also surging.

In the latest note by Morgan Stanley's Jeen Ng, the analyst reports that "fundamental performance deterioration has not been confined to Subprime. Both 60+ day delinquencies and default rates in Prime ABS pools have nearly doubled from their post-crisis lows."

A slightly better picture - at least according to MS data - emerges in terms of loss severities. Still, while subprime losses are far worse, the deterioration among prime loans is unmistakable: compared to peak levels, 60+ day delinquencies in Prime auto loan pools are roughly 65% of the way back, whereas Subprime pools are close to 95% of their peak levels. On the default rate side, the deterioration is somewhat more subdued, with Subprime over 80% of the way back to prior peaks while Prime has yet to reach the 45% mark.

One troubling observation, as confirmed in the recent Fed Senior Loan Officers Survey is that credit standards have continued to ease: as in Subprime, some of the ongoing Prime deterioration can be attributed to a relaxing of credit standards.



Aggregate credit scores have decreased by about 5 points, which while easier is not even half as much as the 10+ point deterioration in Subprime. The same is true for longer origination terms. Most Prime issuers have extended loan terms by 3-4 months over the past 5 years. In Subprime, extension in most cases has been longer than 10 months. These easier standards can help explain both why delinquencies and defaults are higher, according to Ng. Also, keep in mind, there is a limit as to how far Prime issuers can expand their credit box in the form of lower credit scores before the deals become Subprime.

Some more observations from Morgan Stanley, which finds a particular deterioration in recent loan issuance at Huyndai and Mercedes:

As auto lenders expand their credit box to weaker credit borrowers, we should expect to see poorer credit performance among more recent deals relative to the more seasoned ones.



Across the OEM originators above, we see a very consistent shift in lending standards over time - marginally longer loan terms, higher credit scores and lower used car composition. Overall, the longer loan terms and higher credit scores have offsetting effects on fundamental performance. If we look at the 60+ delinquencies and 3-month CDR curves by vintage, we don't necessarily observe performance  deterioration over time, and for some issuers we even see relative outperformance among recent deals. However, we do see higher severities among recent vintages, which we can at least partly attribute to the decline in used car values.


HART (Hyundai) and MBART (Mercedes Benz) serve as exceptions to the above, with a higher % of used vehicles and FICO migration of less than +10 points over the last 7 years. They are also the two shelves which show the most pronounced performance shift. TAOT (Toyota) also extended their credit score by less than 10 points, but their change in origination loan terms has been minimal and they have a lower  composition of used vehicles over time.

Additionally, in terms of loss severities, the bank finds that all originator types appear to be trending higher in similar fashion, with non-bank originators printing the lowest recovery values. OEM originators overtook bank originators to see the highest recovery values last year.

* * *

In a separate, and even more downbeat report, S&P Global Ratings analyst Ann Matin noted that losses in bonds tied to "prime auto loans have surged surged in recent months from a year ago, hurt by falling recoveries" and notes that prime net losses rose to 0.73% in February from 0.57% in same month last year. According to S&P, bonds from some issuers that have become a larger share of the index, including Mechanics Bank’s California Republic and TCF Financial Corp., and both are contributing to those higher losses.  Additionally, the rating agency referred to the abovementioned loan losses at Huyndai, stating that “we’ve increased our expected cumulative net loss levels for certain issuers, including Hyundai’s most recent transaction, HART 2017-A."

Margin also wrote that prime asset-backed deals issued in 2015 seem to be performing worse, comparatively, than those sold between 2010 and 2014, and the deterioration in loans made to strong credit borrowers has forced S&P to revise its net loss expectations for various bonds.

* * *

To summarize: subprime loan losses have been surging alongside loss severities (with the buyside happy to soak up any and all issuance, regardless of underlying fundamentals), as recoveries slide, and in recent months this deterioration has finally shifted over to prime loans. Meanwhile, used car prices are tumbling, while new car sales have declined for 4 consecutive months as auto loan demand among tapped out consumers has tumbled. Meanwhile, millions of used cars are about to hit the market as they come off lease, which in turn will further pressure used car prices and new car sales.

So what happens next?  Here, we'll repeat what we concluded last night:

Unstable used car prices will almost certainly reduce OEM reliance on leases as the implied 3-year depreciation (or residual values, if you prefer) will make them all but completely uneconomical: remember, Americans only care about that monthly payment.  Meanwhile, the relative value between used and new cars will tilt heavily in favor of the used market.  Thankfully Americans will still be able to buy that Mercedes they require to get back and forth from their minimum wage jobs, while maintaining a monthly payment of $500 or less, but it will just have to have 30,000 miles on it.

Of course, the OEMs of the world won't admit that their game is over until it's way too late.  So, they'll keep right on producing new cars to cover a 17-18mm SAAR environment up until the point they face an outright revolt from their dealer networks.  At that point, however, dealer inventories will be so high that Detroit will be forced to shutdown for months on end while new car prices are slashed to reduce the massive inventory glut.  Tanking new car prices will put even more pressure on used car prices which will mark the beginning of the death spiral that will result in a new round of inevitable auto bankruptcies, catalyzing the next economic contraction... assuming one hadn't started already.

Comment viewing options

Select your preferred way to display the comments and click "Save settings" to activate your changes.
ACP's picture

Should've bundled them and sold them to the stupids in Europe again.

ebworthen's picture

This has been building for quite some time.

A year ago my Girlfriend's Son, who had defaulted on 4 car loans in the past 5 years, got $20,000 to get a loan.

The year before that, it was getting a loan for $15.000 for defaulting on 3 car loans. 

Bill of Rights's picture

We deserve rates in the triple digits for this sort of reckless behavior

TheReplacement's picture

I'm not giving out loans to people who really can't afford them.  I'm not printing money.  I'm not holding rates at artificially low levels.  Furthermore, there doesn't seem to be a damn thing I can to to materially change all of it, one way or the other.


Who is the "we" of whom you speak?

Zero_Ledge's picture

What causes the annual seasonality in default rates?  Christmas? New model year turnover?

CJgipper's picture

You pay taxes, so yes you are.

GUS100CORRINA's picture

The Other Shoe Drops: Prime Auto Loan Losses Surge As Recoveries Tumble

One thought: NOT GOOD.

indygo55's picture

Maybe your girlfriend is really hot and the auto salesman wants to keep lookin'.

Cordeezy's picture

Well when will the deals on cars come out? Who services these loans? I am just wondering if there will be a bail out or not. The supply of used cars has gone up so if this causes buyers to go down then we should see good deals soon.

Sonny Brakes's picture

I think they'll crush cars coming straight off the line before they'll ever let them be sold at prices reflecting market conditions. Same thing goes for used cars coming off of leases. Accounting rules will be changed to help keep prices from falling before they'll ever let their monopoly suffer the consequences of oversupply.

motorollin's picture


Generally Accepted Automobile Accounting Practices

Gargoyle's picture

Generally Accepted Automobile Accounting Problems.



GunnerySgtHartman's picture

GMAP: General Motors Accounting Practices.  They are going down the same road they went down 10 years ago, cut-rate financing/lease deals to subprime borrowers to keep the lines busy and the cash flow going.  This picture does not end well.

FCA will not exist in its current form five years from now - count on it.

coast1's picture

I only watch the screen on nights when tired after a long days work...say what you want about netflix but I did find some good ones that keep me entertained and out of the local bar :-)    SOns of Anarchy about motorcyle gangs,...breaking bad about a guy who had cancer and was a chemist, and decided to make the best meth in the world to make money for his family whn he died...But the latest?  House of Cards.... It shows about 25% of what politicians, they dont show AIPAC, nd all the other things we know of, but it does show a part of the corruption in D.C.   Even tho its only 25%, its better than nothing....Anyway, maybe off topic, just felt like sharing...prison break was awesome closing, IMHO, peopl who visit this website and make comments are of the most intelligent...not everyne, but most...thank you guys sometimes I feel alone and you all cheer me up a bit...

Clock Crasher's picture

I jump straight to the comments as of late.

Cheers brother.

We are living through an epic war between Truth and Pure Evil in real time. Blade running.

Clock Crasher's picture

DOW gaps up over 1% first thing Monday. This another nail in QE14 coffin .. I mean QE 4.

ThrowAwayYourTV's picture

The last thing we need are more f#$%ing cars, man. We got F#$%ing cars coming out our a$$e$, man.


HomelessPatriot's picture

So I guess auto insurance rates will be cut in  half by 2019 as values drop . Great deal!

silverer's picture

Not a problem. The borrowers simply bought those cars for the banks. They are safely owned by the lenders. If there's any problem, the entire US population will cheerfully help out, like they did the last time.

SmittyinLA's picture

I bet a lot of $30-$40K SUVS with 30K#40k miles are pretty much worthless due to shit quality engines by design, expensive part "x" goes out and the car is worthless, part of the state's "force everybody into public transportation to control them" program.

Light weight high compression engines designed to last to their warranty period at best, what could possibly go wrong?

Another thought, are the France car fires a beard for insurance fraud?

Is everybody in America gonna start having problems with Muslims torching their cars?

Mohammad did it?

Falling Down's picture

They don't call it engineeered obsolescence for nothing...


My mother just got her 2nd Chebbie Malibu, her first ever lease. I told her she was nuts, there are plenty of used crossovers and whatnot from a bunch of different automakers. Nope, she wants another shit box from Chebrolet. They got rid of the Ecotec I see, it was designed to fail by 150,000:

1.5L 4-cylinder DOHC engine with turbocharger, DI and Variable Valve Timing (VVT)

Yeah, just wait 'til the recalls start flying with this one...


Kat Daddy's picture

Time for a lightly used new car!

Ban KKiller's picture

Higher yield...greed works.

Grandad Grumps's picture

I guess the banks sucked a little too much out of the middle class...

... or maybe that was the intention and the losses mean nothing for a banking system that creates as much fiat as it wants out of thin air.

moorewasthebestbond's picture

Pimp my repossessed ride.

Blankfuck's picture

One thing is for sure, The FED Reserve Fuckers will always fuck things up except the wealthy who makes money off the poor bastards that gets sucked in

Silver Savior's picture

I guess encourage more vehicle ownership? Get some of these millennials a damn license? Crush cars? Give them to the needy? Ship the excess inventory to Africa? Hide them? 

silverer's picture

Drain the fluids. Roll down the windows. Instant offshore reef.

Yen Cross's picture

   Shadow puppet / Theatre

FredGSanford.'s picture

I saw a sign on the front of a furniture store a few days ago 'No interest or payments till 2019'. Maybe car dealers could try that. Also, since new cars now cost as much as houses used to cost , how about a 30 year mortgage on a car? That would keep the payment low and keep idiots buying them.
Just thinking of ways to keep the Ponzi going!!!

Last of the Middle Class's picture

How could recovery be a fucking problem? They all have GPS! Damn fools, drive out there and take the care. But you see that's not the problem, the problem is massive government interference in the normal supply and demand cycle have grossly distorted the market such that the auto market, not unlike the ACA is sucking every available extra dollar out of the family expenses and THAT, my friend, is the problem. You can't buy a $60,000 Escalade finance it on 72 months and make the payments living in mom's garage while flipping burgers. Blame it on recovery! What a crock.


I just bought a new Honda Ridgeline. I was going to pay cash but the rates are so low why not take advantage. Mine is around 2% and a monthy payment of around $200. If these rates are available why not take advantage of them? Hondas do seem to last so I hope this one does. But I do miss the 2006 Tacoma with 200k plus miles on it that I traded in.

silverer's picture

Only 200K? Why did you trade your new truck in for a loan?

Abbie Normal's picture

You can put whatever you saved by borrowing at 2% vs. paying cash (i.e. nothing) towards the inevitable transmission replacement that Honda will need in a few years.  None of the Honda V6 transmissions are reliable beyond 60K.

silverer's picture

Wonder what the default number will hit when the US hits the Big One? 10%? 20%? Even higher? Keep in mind that when the cars go, it's a sure sign of trouble in basic America, because the CAR is everything to so many people. Drive past the home, which is literally falling apart, but there's a brand new loan proudly parked out front, which represents and projects the borrower's ego. Take that away on a hook, it will surely be replaced with riots and civil war.

CNONC's picture

This article could be used as an exemplar of how to manipulate math, charts, and statistics to sell an idea.  The first chart shows a clear cyclicality, yet the author chooses to use a superimpose a trendline which starts at a cycle low and ends at a cycle high.  With used car prices, he uses a graph without a zero reference to exaggerate a small decline in prices.  I absolutely expect problems to develop in the used car market in the future, with the bulk of the problems caused by returning off lease cars.  But auto lending is one of the few areas where risk seems to priced accurately.  The interest rates charged to these subprime and deep subprime borrowers currently seems to be more than sufficient to compensate for the increased risk.  At some point, AFTER the economy slows substantially, these default rates will rise, recovery rates will fall, diminished value and early lease returns will rise and, finally, used car prices will fall. But I see no evidence for an immminent, lasting, 50% fall in prices except as a result of a repeat of 2008.  The author has presented no evidence suggesting such a thing. 

Somebody is talking their book.

all-priced-in's picture

One thing I don't understand -


If 12 millions vehicles are coming off lease - wouldn't the person turning it in still need a vehicle?


I bet 95% of them turn around and lease another vehicle -


If money was really tight they could sign a new lease on the same vehicle.









Abbie Normal's picture

Or maybe they no longer qualify for a new lease due to the changing economic conditions.

Or maybe they got smart and decided to buy a reliable used vehicle and drive it into the ground.

yellowsub's picture

If there's a ton of pickups not sold on lots, we know where they're headed...