Amid a cacaphony of pundit parroting about strong US auto sales — which culminated in CNBC’s now infamous “car-stock arbitrage [5]” recommendation — we have said repeatedly that at the margin, growth is being driven (no pun intended) by lenders’ willingness to extend credit to underqualified (read: subprime) borrowers. This was later confirmed by Goldman [6] in a note which pointed out that subprime loans accounted for more than a fifth of all US new vehicle sales in January, which is 500bps above the post-crisis norm of 16%. Furthermore, as of January, the percentage of new vehicle sales attributable to subprime loans had been running ahead of the post-crisis average for 7 straight months.
It doesn’t take a leap of logic to determine the reason for the trend towards subprime (via Goldman): “We attribute the ongoing strength in subprime to (1) pent-up demand by subprime borrowers as lenders pulled back significantly from subprime auto lending during the recession and 1-2 years afterwards, and (2) the low interest rate environment, which has made subprime loans more attractive for investors chasing yield.”
In other words, it’s the same story everywhere you look, whether it’s elevated HY issuance by insolvent E&P companies or heavy demand for ABS backed by subprime auto loans: investors are starved for yield and they’ll take it wherever they can find it even if it means forgetting that an 11% coupon on a new issue from a struggling oil producer likely spells trouble or disregarding a 550 average FICO on the latest billion dollar subprime auto ABS securitization.
As we’ve pointed out on a few occasions, the appetite for Santander Consumer’s “deep” subprime DRIVE 2015-A [7] demonstrates the extent to which the hunt for yield is once again driving Wall Street’s securitization machine which is in turn incentivizing lenders to lower their standards in order to lure more buyers.
For those who demand still more proof, consider the following which shows that the subprime and leasing sub-sectors of the auto-related ABS space are the only two sub-sectors to show Y/Y growth in issuance every year since 2012, and looking at the figures for Q1 2015, it certainly appears as though this could be a banner year for subprime ABS issuance.
And as the following commentary from BofAML makes clear, auto-related securitizations are driving the market for consumer ABS issuance:
The auto ABS market continues to dominate new issue volume with 53% of the total ABS volume. Prime auto loan ABS represents the largest sub-sector with 32% of auto ABS volume and 17% of total ABS volume. Non-prime auto loan and auto lease ABS saw nearly the same amount issued.
In this type of environment, one would certainly hope that credit fundamentals are not deteriorating in the subprime auto space. Unfortunately, they are:
The trend in credit performance for the non-prime auto loan sector is clearly more negative than the prime auto loan sector. The 30+ days delinquency and net loss rates for the non-prime sector continues to trend up, while the same for the prime sector have been relatively stable. Even though net losses for non-prime loans are below normalized levels and employment situation continues to improve, the trends in 30+days delinquency and net loss rates argues for tighter lending standards in the sector. Based on normalized levels we expect to see net losses increase by another 50bp in the prime auto loan market and 110bp in the nonprime auto loan market.
Meanwhile, the trend is not your friend when it comes to subprime net loss rates which despite having ticked lower in February, are still at their widest levels compared to prime in years...
[8]
...and predictably, the percentage of buyers opting to finance is trending higher as interest rates remain suppressed by Fed largesse...
[9]
Here's more, via Deutsche Bank:
With interest rates still low, buyers today rely more on financing to purchase their vehicle. According to Experian Automotive, in Q4 2014 84% of new vehicles and 55% of used vehicles were financed via lease or loan. This compares to 2009 when 74% and 46% of new and used vehicles, respectively, were financed.
This has supported auto ABS issuance, a trend which we expect to continue
throughout 2015. Auto ABS issuance totaled $7.7 billion in March, bringing
YTD new issue supply to $30.1 billion. Nonprime auto ABS issuance totals
$7.2 billion year-to-date. Overall, auto ABS issuance is up 13% year-over-year.
* * *
We'll close with this, because nothing spells trouble like the idea that if you have the cash, you should take out a loan with a rapidly amoritizing asset as collateral in order to invest in stocks or, in other words, it's a good idea to pledge a devaluing asset to buy an overvalued asset..
Bonus video (F-Series pickup sales fell nearly 5 percent in March): "Trucks, trucks, trucks"...
