Never underestimate the creativity of business people in need of new business and investors in need of something in which to invest.
After the financial crisis decimated the market for bundled home loans that weren't backed by the U.S. government, bankers and lenders seized on a host of alternative assets that could be sliced and diced and served up to investors. Sales of commercial mortgage-backed securities (CMBS), along with collateralized loan obligations (CLOs) consisting of loans made to junk-rated companies, subsequently surged past their precrisis highs. Bonds backed by auto loans made to riskier borrowers also proved to be a sweet spot for yield-seeking investors and the companies and bankers that sold such debt to them. People might walk away from their homes, so the bull case went, but in the driving culture that is America, very few would ever willingly choose to fall behind on their car payments.
This state of affairs encouraged new lenders to pile into the subprime auto lending space, including Exeter Finance Corp. and Skopos Financial. Skopos hit the headlines last year for peddling two deep subprime bond deals featuring ultralow credit scores and sometimes no credit scores at all. The concern has been that such upstarts, often backed by private equity firms, will lower their underwriting standards as they fight for market share in an effort to produce relatively quick returns.
Last week it appeared the chickens had come home to roost for some subprime auto lenders and investors, with Fitch Ratings warning that delinquencies in subprime car loans had reached a high not seen since October 1996. The number of borrowers who were more than 60 days late on their car bills in February rose 11.6 percent from the same period a year ago, bringing the delinquency rate to a total 5.16 percent, according to the credit rating company.
The headline figure, however, conceals a wide disparity in delinquencies.
Fresh data from JPMorgan Chase & Co. show a dramatic bifurcation in the fortunes of issuers of U.S. subprime auto asset-backed securities (ABS). While overall delinquencies in JPMorgan's subprime auto index have increased in recent months, much of the jump can be traced back to the new issuers crowding into the booming industry, the bank's securitization analysts say.
At issue is the influence of new lenders experiencing higher rates of late payments. The weights of AmeriCredit and Santander Consumer USA Holdings Inc., two stalwarts of the subprime auto lending industry, have fallen as new ABS programs have eaten up market share. The weighting of 11 issuers with the highest delinquencies (excluding some deals sold by Ally Financial, AmeriCredit, and Santander) has increased to 28 percent, exceeding Santander's 25 percent share and far exceeding the mid- to single-digit share reported from 2011 to 2013.
Delinquency rates for these newer issuers have often been higher relative to more established players. For example, the 60-day delinquency rate for subprime auto ABS deals sold by Exeter is almost 10 percent following 20 months of aging, compared with the 2.3 percent rate at more-established player AmeriCredit in the same period and vs. a high of 4.5 percent reached in 2000. New ABS programs launched by GO Financial and Skopos just last year, meanwhile, are already seeing delinquencies running into 6 percent at less than 12 months of so-called seasoning, according to JPMorgan.
"The signs of competitive pressure from new entrants, such as Exeter, have been emerging over the past few years," write JPMorgan analysts Amy Sze and Christiana Wong. "This portends even higher delinquencies ahead for the sector as a whole as the portfolios of the newer and weaker performing issuers (relative to historical AmeriCredit) season. This deterioration will also further be compounded as new entrants tend to seek higher growth and bigger market share versus established players."
Still, the analysts remain relatively sanguine over the fortunes of the subprime auto ABS market as a whole.
"The delinquency trends at the issuer-level tell a more accurate story and suggest a much more benign outlook, in our view, for subprime auto lending and ABS investors," write the JPMorgan analysts. "The deteriorating credit trends have been developing since 2011 and should not come as a surprise to auto ABS investors. Consumer lending is a cyclical business and new entrants and looser underwriting should be expected during an expansion."
They add, however, that "performance for newer issuers is harder to predict given the lack of historical performance data through a prior full economic cycle."
Here it is worth noting that the same dynamics that have drawn a host of new issuers into the business of subprime auto lending have also been at play across CMBS and CLO markets, too, with many new entrants jumping into their respective markets in recent years. It seems business interests, like business cycles, never really go away.