Subprime auto defaults on path toward 2008 crisis levels, say portfolio managers

By Joy Wiltermuth

The surge in easy credit during the pandemic, government stimulus payments, and skyrocketing car prices have all begun to bite borrowers with the lowest credit scores.

Subprime borrowers who financed used cars at record prices in recent years have been acting more stressed than during the 2008 global financial crisis, even though the labor market has been resilient, according to a new report from fixed-income asset manager Bramshill Investments.

While inflation and higher interest rates have been eroding paychecks of all U.S. consumers, “it is very apparent to us that it is negatively affecting subprime borrowers (who tend to have lower credit scores and lower incomes) more harshly than others,” portfolio managers Paul Van Lingen and Ara Balabanian wrote, in a new monthly client note.

“All else being equal and continuing the current path, we are assuming defaultsand recoveries will continue to deteriorate more toward levels not seen sincethe GFC.”

The duo pointed to 60-plus day delinquencies hitting 9% in March for borrowers with credit scores of 550 and below when looking at subprime auto loans packaged into asset-backed securities, or bond deals. That’s up from a rate of about 7% in March 2019 before the COVID crisis.

They also studied evaporated savings of the lowest income borrowers since mid-2021 peak levels, and anticipate a greater share of all U.S. consumers will “run out of excess savings,” in the months to come, leaving them vulnerable to missing payments and delinquencies.

Perhaps more alarming, the 1-month constant default rate for subprime auto bonds, or asset-backed securities, already was nearing 12% (see chart), on a path toward the 16% peak seen in the wake of the global financial crisis.

The Bramshill team expects fundamentals to “bottom out,” such as unemployment increasing, which may cause defaults and recoveries to reach more “distressed levels” and potentially trigger forced selling “at very attractive valuations.”

They haven’t been the only ones sounding alarms about the toll of the Federal Reserve’s rapid pace of interest rate hikes to fight inflation. Bond-trader Jeffrey Gundlach also said this week that he was getting more bearish, including on riskier parts of the credit markets, and that banking stress isn’t likely to be over until the Fed starts cutting interest rates again.

Companies that issue subprime auto bonds have been paying more for funding in 2023, according to Finsight, with recent BB rated bonds fetching coupons of nearly 10% and top AAA rated bonds going for closer to 5.5%.

The cash-burning used car trader, Carvana Co. (CVNA), recently paid 10.5% to sell BB+ rated bonds in the ABS market, according to Finsight.

U.S. stocks were sharply higher Friday after a strong April jobs report and robust earnings from Apple Inc., (AAPL) but with the Dow and S&P 500 index still facing weekly declines.

Related: U.S. consumer credit growth accelerates in March

-Joy Wiltermuth

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05-06-23 1116ET

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