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.
This is interesting news, but not quite in line with the market at all. If anything, this company could have been positioned to capitalize on the existing market now, if not the near future. Clearly, a lack of understanding the auto finance market and experience, from a Management perspective.
The first and best way to evaluate any company is to look at the Quality of Management. Both Ability and Integrity are key elements. Adversity is the true test of Management – so who is evaluating the quality of management at these originators for the private investors? High returns = high risk.
Bystanders can sit back and watch a repeat of the prior sub-prime lending cycles. Moody’s (if they can be trusted anymore) is sending up a flare, I hope that bank auto finance executives do not succumb too much as the looser deals impact their volume. New car volume is up substantially from several years ago so there is opportunity to let the truly sub-prime deals go to the sub-prime originators. Hopefully the underwriting algorithms remember that indirect auto is primarily collateral value lending.