Bonds Backed by Auto Loans Look Toxic

You might think we were headed straight for Carmaggeddon. Car sales are at their lowest level in more than two years; subprime delinquencies are nearing their crisis-era highs. Deep subprime -- loans accessible to the least creditworthy borrowers -- represent a third of the subprime car-loan backed securitization market. Seven-year loan terms are now the norm as borrowers stretch themselves precariously thin to make their paychecks match their payment capacity. The New York Fed says 6 million debtors have fallen behind, with many more to come. And of course, used car prices are crashing, devastating the collateral lenders can recoup at auction.

So why aren’t investors in the auto-loan backed securitization market a wee bit alarmed? If anything, pricing in this market indicates performance of auto ABS is expected to improve: According to investors in this arena, a year ago, buyers of the riskiest slices of these bonds were demanding yields that were 7.50 percentage points over comparable four-year maturity swaps, the fixed-income instrument against which they are priced. As of the end of the first quarter, that premium had been cut in half.