Seasoned Loans Outperform Unseasoned Loans in Subprime Securitizations — Eventually

Fresh research from Kroll Bond Rating Agency shows that, contrary to popular belief, seasoning may not be the most accurate indicator of a subprime loan’s performance.

Data from KBRA’s Subprime Auto Loan ABS report published Thursday illustrates that “very seasoned” subprime loans — those with 48 months of payment history — exhibited higher net losses than loans with less than 12 months of seasoning, at least initially. KBRA refers to the less-seasoned loans as “newly originated.”

“Conventional wisdom has it that seasoned loans will outperform newly originated loans,” the report read. The logic is that the longer a borrower has been making loan payments, the more equity is built up in the asset. Higher seasoning also typically means the borrower has demonstrated willingness to make future payments. That said, “subprime auto loans appear to buck the conventional wisdom,” the report stated.

For instance, in the first year of GM Financial’s 2017-1 securitization, loans with at least 48 months of seasoning exhibited higher cumulative net loss rates than did the newly originated loans. But 16 months into the securitization, cumulative net losses in the seasoned tranche trended toward expected levels, dropping below those recorded by the newer loans.

The same trend can be seen in Santander Consumer USA’s two ABS transactions in 2017. Cumulative net losses were about 1.5 times higher for the seasoned loans than for the newly originated loans in the same time period.

KBRA explored several potential drivers for the seemingly uncharacteristic loss rates. Unlike prime loans, subprime loans generally exhibit losses regardless of seasoning. The poor credit quality and lack of financial security among many subprime borrowers typically results in a “much steeper loss curve over time,” KBRA wrote.

Loss severity also plays a role. “Although older loans have had more time to amortize and the rate of depreciation usually declines as a vehicle ages, severity rates are generally around 20% higher on very seasoned subprime loans,” according to KBRA.

Another factor influencing loss rates in seasoned loan pool is what KBRA dubbed “survivorship bias,” which refers to the fact that better credit borrowers are more likely to repay their high interest rate subprime loans as quickly as possible. As such, loans that remain after 48 months of seasoning may be skewed to poorer credit quality borrowers.

In a nutshell: While a higher percentage of very seasoned loans will typically be a “credit positive” for a subprime securitization, the benefit is often murkier in the early months of the transaction, KBRA wrote.

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