Typically, the most risk in auto loan asset-backed securities (ABS) resides in the subprime space stemming from the lower credit tiers connected to that paper. Well, S&P Global Ratings is seeing risk grow within prime ABS, too.
Because finance companies are addressing consumers’ shifting preference for larger, more expensive vehicles by extending contract terms up to 84 months, the newest report from S&P Global Ratings explained those term modifications increase credit risk and are causing losses to be more back-loaded in U.S. prime ABS.
“We believe longer-term loans will become increasingly popular among the auto manufacturers' captive finance companies, and these entities will join certain banks in including 84-month loans in their ABS,” S&P Global Ratings said.
“As the percentage of longer-term loans increase in U.S. prime retail auto loan securitizations, S&P Global Ratings will continue to analyze static pool vintage performance by loan term and adjust its expected loss levels on the pools accordingly,” the firm continued.
“To the extent that these loans represent greater risk for an issuer's pools, our expected cumulative net losses are likely to increase, which could result in higher credit enhancement levels,” the firm went on to say.
According to Experian, the most common term for a new vehicle is now 72 months with terms in the 73-84 month range now representing 30% of new-vehicle origination volume as of the fourth quarter. The report elaborated why that backdrop can be especially problematic in the new-vehicle financing space as finance companies fill securitizations with elongated contracts.
“Credit risk could increase as the amount of longer-term loans in these pools rises. Because new vehicles depreciate rapidly, especially in the first three years, the loan balance often exceeds the depreciated value of the vehicle for the first few years. Therefore, absent a large down payment, the severity of loss upon a repossession is generally substantial (40%-50%). To the extent that loan terms lengthen, the severity of loss could increase due to the slower amortization of the loan balance,” S&P Global Ratings said in the report shared with SubPrime Auto Finance News.
“Additionally, because longer-term loans delay the point at which a borrower starts to build equity in the vehicle (and could sell it to repay the loan), the borrower may have less incentive to continue making payments on the vehicle in the event of financial distress. Moreover, longer loan tenors increase the likelihood of the borrower experiencing a job loss or a medical emergency while the loan is outstanding. These and other such events jeopardize the borrower's ability to make payments on time and in full,” the report went on to say.
The complete report can be secured here.