Why America’s $1.3 billion auto loan market can’t avoid a pileup

Of all the industries that escaped the 2008 financial crisis relatively unscathed, few surprised more people than the auto lending industry. At the time, it was expected that the wave of defaults hitting the mortgage market would also sweep through the automotive sector.

But cash-strapped borrowers continued to prioritize car payments over homes and credit cards. The logic seemed clear: you can sleep in your car, but you can’t drive to work. Now, however, the $1.3 billion industry – about 60% larger than it was then – faces an entirely different set of threats.

Not only are millions of people out of work, but governments are calling on everyone to stay home to limit the spread of the coronavirus. This raises questions about whether borrowers will continue to put their car first when cash is tight.

Another big difference between 2008 and today is that this crisis is hitting those at the lower end of the credit spectrum the hardest. The Great Recession created many economic strife for the wealthy, but today low-income “subprime” borrowers are suffering as the restaurant, retail and service sectors are decimated, says Rosemary Kelley , head of asset-backed securities at Kroll. .

Given that the risky car market was showing signs of strain before the crisis – with millions of people in arrears last year – the pandemic could create the perfect storm that bearish investors have been waiting for.

“There were already cracks in the armor. Now, with the coronavirus, it’s even more downward pressure,” said Joe Cioffi, chairman of the insolvency and creditor’s rights practice at Davis & Gilbert, a law firm.

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

ABS originators typically try to build portfolios that can withstand “astronomical” levels of default, Cioffi said. But this time, the problem isn’t loose underwriting or a lack of additional protections for high-profile investors. “No one predicted this kind of shock to the economy,” he said.

For subprime lenders, a market dominated by nonbanks, the biggest issue is liquidity, said Amy Martin, senior director of S&P Global Ratings. “Right now it’s very difficult to access the capital markets,” she said. “ABS markets are basically closed.”

So far this year, nearly $26 billion worth of automotive ABS securities have come to market, according to Finsight, a data provider. But there has been no broadcast for more than three weeks.

This means that it will be important to keep an eye on issuers’ lines of credit, which can be drawn down if default rates, loss rates, payment extensions or other metrics begin to violate certain triggers outlined in restrictive clauses.

“We’ve found that businesses can stay in business for a while losing money, but go bankrupt very quickly when they lose access to their warehouse lines of credit,” Ms. Martin.

Credit Acceptance Corp, one of the largest non-bank lenders, has six warehouse lines worth a total of $1.2 billion, for example, according to its latest annual report. Since late January, the Southfield, Mich.-based company’s share price has halved. But it, or any other lender, is unlikely to be at immediate risk of losing those lifelines, analysts say.

It may take a few weeks before problems start showing up in lender-to-investor reporting, said BTIG analyst Giuliano Bologna. Most of those laid off or out of work since the outbreak are still likely to receive paychecks this month, so the cycle of defaults hasn’t really started yet. “A lot of [lenders] receive calls from borrowers asking for help,” he said. “But those are things that wouldn’t go through the data.”

The main variables are now the proper functioning of the US government’s recovery plan and the duration of the crisis.

With companies such as Ally Financial and Santander Consumer USA offering borrowers forbearance, this could provide ample time to avoid widespread defaults if the economy quickly gets back on track. However, such measures may just be kicks in the box.

Once the forbearance expires, these businesses’ credit performance could “deteriorate rapidly, particularly if displaced workers are unable to find jobs and businesses cannot resume operations once the economy reopened,” Fitch analysts said in a statement. research note this week.

Unless the government gives people enough money to sustain their payments through the crisis, the losses will start to pile up, Davis & Gilbert’s Mr. Cioffi said.

“Two months from now you’ll see the ‘sky is falling’ speech that nobody wanted to do before,” he said. “Auto subprime was sick. Now he’s probably going to be in triage.

Priscilla C. Carnegie