Private Equity, Riskier Securitizations Could Pose Threats to Subprime Sector, Moody’s Says

Moody’s Investors Service looked into its crystal ball and saw that declining loan credit, increased competition for originations, and ample funding for asset-backed securities indicate higher credit losses in the subprime auto lending space are on the horizon. 

Sure, that’s something that’s been talked about around the industry for several years now, but the company’s new report — entitled “Risk Factors Still on Rise for U.S. Subprime Auto ABS” — mention specific factors that show what’s just under the surface.

Specifically, there are more companies backed by private equity and an increasing number of securitizations that include unseasoned — also known as prefunded — loans.

Of the former, Moody’s cited companies such as Pelican Auto Finance, White River Capital, and First Investors Financial Services, which have looked to private equity firms for investments in the subprime space and may be at risk of losing sight of the past. Equity investors’ desire for high returns can put originators into funding loans for lower credit tiers, and a rise in losses can cause investors to pull their financing.

Prefunded subprime ABS issuance, meanwhile, has grown in popularity. From early 2011 through most of 2012, Consumer Portfolio Services was the only issuer that included in its securitizations these unseasoned loans, which are more susceptible to first-payment default. Since December 2012, though, American Credit Acceptance, Santander, Prestige, Flagship, United Auto Credit, and J.D. Byrider have all issued ABS deals backed partly by prefunded loans.

Prefunding can weaken credit quality if it’s used to expand origination volume too quickly, and can indicate that an originator is trying to speed growth, according to Moody’s.