Why America’s $ 1.3 trillion auto loan market can’t avoid a pile-up

Financial services updates

Of all the sectors that weathered the 2008 financial crisis relatively unscathed, few surprised more people than the auto loan industry. Back then, there was widespread expectation that the wave of bankruptcies in the mortgage market would inundate the auto sector as well.

But insolvent borrowers continued to prefer paying off their cars over their homes and credit cards. The logic seemed clear: you can sleep in the car, but not drive to work. Now, however, the $ 1.3 trillion industry – about 60 percent larger than it was then – is facing very different threats.

Not only will millions of people be unemployed, but governments are urging everyone to stay home to help curb the spread of the coronavirus. That begs the question of whether borrowers will continue to put their cars above everything when money runs out.

Another big difference between 2008 and today: This crisis hits those on the lower end of the credit spectrum harder. The Great Recession has created a lot of economic hardship for wealthy people, but today, less well-off “subprime” borrowers are taking the brunt as the restaurant, retail and service industries are decimated, said Rosemary Kelley, head of asset-backed securities at Kroll .

Given that the subprime auto market showed signs of tension before the crisis – with millions of people defaulting on their payments over the past year – the pandemic could spark the perfect storm bearish investors have been waiting for.

“There were already cracks in the armor. Now with the coronavirus, the downward pressure is even greater, ”said Joe Cioffi, chairman of the bankruptcy and creditor practice at Davis & Gilbert, a law firm.

That means lenders and investors in asset-backed securities could be at risk.

ABS originators typically try to build portfolios that can withstand “astronomical” default rates, said Mr Cioffi. But this time around, the problem isn’t with loose underwriting or a lack of extra protection for the senior investors. “Nobody predicted such a shock to the economy,” he said.

For subprime lenders, a non-bank dominated market, liquidity is the biggest concern, said Amy Martin, senior director at S&P Global Ratings. “Access to the capital markets is very difficult at the moment,” she said. “ABS markets are as good as closed.”

According to Finsight, a data provider, nearly $ 26 billion in auto ABS securities have hit the market so far this year. But there has been no issue at all for more than three weeks.

This means that it will be important to keep an eye on the issuer’s credit lines, which can be withdrawn if default rates, loss rates, payment extensions or other metrics start to violate certain triggers set out in covenants.

“We have found that companies can stay in business for a while and lose money, but they go out of business very quickly when they lose access to their inventory credit lines,” said Ms. Martin.

For example, Credit Acceptance Corp, one of the largest non-bank lenders, has six storage lines valued at $ 1.2 billion, according to its latest annual report. The Southfield, Michigan-based company has had its share price halved since late January. However, it is unlikely they or any other lender would be in imminent risk of losing those lifeguards, analysts say.

It can take a few weeks for problems to show up in lenders’ reports to investors, said Giuliano Bologna, an analyst at BTIG. Most people laid off or unemployed since the outbreak are likely to still receive paychecks this month, so the default cycle has not yet properly started. “Many [lenders] receive calls from borrowers asking for relief, ”he said. “But these are things that would not flow through to the data.”

The big variables now are how well the US government’s stimulus package is working and how long the crisis has lasted.

With companies like Ally Financial and Santander Consumer USA showing borrowers forbearance, it could buy enough time to avert widespread defaults if the economy quickly gets back on track. However, such measures can only kick the can on the street.

After the indulgence expires, these companies’ creditworthiness could deteriorate “very quickly, especially if laid-off workers cannot find employment and companies cannot restart operations after the economy reopens,” Fitch analysts said in a research note this week.

If the government doesn’t give people enough money to keep their payments going for the entire crisis, losses will inevitably pile up, said Davis & Gilbert’s Mr Cioffi.

“Within two months you will be seeing the ‘sky is falling’ talk that nobody wanted to do before,” he said. “Subprime car was sick. Now it will probably be in triage. “

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