Recent subprime-auto bonds from Prestige Financial Corp. and Exeter Finance Corp. are performing worse than anticipated, at a time when many competitors are at least meeting expectations, according to credit raters.
The challenges both face may be remnants of a push for rapid growth a few years back, when these smaller lenders temporarily loosened credit standards to compete against big banks for loan volume, S&P Global Ratings said in a report Monday. Competition intensified from 2014 to mid-2016 as several subprime auto asset-backed security issuers offset lower profit margins with higher loan volume.
“Certain companies may have sacrificed adequate controls and dealer oversight for the sake of growth,” S&P analysts led by Amy Martin said in a Monday research note. “Renewed growth in subprime lending, which began in the second half of 2018, could intensify competitive conditions and lead to weaker performance.”
Prestige’s post-recession strategy to expand its territory and dealership base led to higher delinquencies, which remain elevated in some cases even after it tightened underwriting several times in the last five years, S&P said. Its target market consists of credit-impaired buyers, and loans to individuals with a recent bankruptcy made up between 38 and 51 percent of outstanding deals, according to S&P. Prestige did not immediately provide a comment.
Meanwhile, Exeter’s latest deal has higher loan-to-value ratios than past asset-backed transactions, meaning more of the underlying borrowers are underwater on their car loans. Weighted average FICO scores in Exeter’s pool slid to 556 from 577, leading Moody’s Investors Service to increase loss projections. S&P, which also rates some Exeter transactions, said the changes may have come as a result of competition.
Despite losses in the loan pools, bond investors rarely see a loss on these types of securities. That’s because issuers bake in strong credit protections to insulate them from losses. Many lower-rated slices of subprime auto bonds actually get upgraded, as the bonds pay down and cash flow is diverted to cover loan losses.
S&P raised loss expectations for the second time for a 2016 ABS from Salt Lake City-based Prestige, revising expected lifetime losses to a range of 16.7 percent to 17.2 percent from an original estimation of 13 percent to 13.75 percent. It also raised loss estimates for a 2017 trade.
Moody’s raised expected losses 1 percentage point to a total of 22 percent for Blackstone-backed Exeter’s latest transaction, versus its previous auto-loan bond as the performance of Exeter’s recent securitizations has been deteriorating.
“Notwithstanding Moody’s loss expectations, Exeter remains confident in our recent origination vintages and fully expects the assets to perform to our expectation,” Jason Grubb, chief executive officer of the Irving, Texas-based company, said in a statement emailed to Bloomberg News.
Minority of Programs
Such credit deterioration may be limited to only a handful of securitization programs and losses on 17 other auto asset-backed securities deals from a variety of issuers are expected to be lower, according to S&P. Subprime auto-bond losses overall have generally stabilized across the board.
“After several years of rising collateral losses in U.S. subprime auto loan asset-backed securities, cumulative net losses appear to have stabilized, albeit at relatively high levels,” S&P analysts said. February, the latest month for which data is available, showed strong month-over-month performance with the first quarter of the year including tax refunds “consumers often use to pay down their loans,” according to S&P.
These overall improvements appear to be correlated with the reduction in industrywide subprime originations in 2016 and 2017, and the implementation of tighter credit standards, the analysts wrote.
Still, keep an eye out for competition heating up again, which often leads to looser controls, the analysts said. For example, even though bond investors appear to be adequately protected, so-called deep-subprime borrower performance is the worst since the financial crisis for the auto-loan sector.
Meanwhile, the loss rate for subprime-auto ABS rated by S&P, including deep-subprime programs, hit a post-crisis high of 9.65 percent in January, although it decreased to 8.67 percent in February. The 60-day delinquency rate also hit a post-crisis high of 5.63 percent in January, though has slightly improved on seasonal factors.
Investors Want More
Investors haven’t been scared off and are demanding issuers sell more junk-rated slices of each deal.
BBB and lower-rated ABS issuance that was “minuscule” before the financial crisis has “surged relative to the total ABS supply in recent years,” JPMorgan Chase & Co. said in a Friday research note. The bank’s BB subprime auto ABS indicative spread stands at “the tightest level recorded since we started tracking the series in 2010.”
— Adam Tempkin (Bloomberg)