Why America’s $1.3tn car-loan market cannot avoid a pile-up
An industry that survived the last crisis reasonably well is unlikely to do so again
Of all the sectors that escaped the 2008 financial crisis relatively unscathed, few caught more people by surprise than the auto lending industry. At the time, there were widespread expectations that the wave of defaults hitting the mortgage market would wash over the auto sector as well.
But cash-strapped borrowers continued to prioritise paying off their cars over their homes and credit cards. The logic seemed to be clear: you can sleep in your car, but you cannot drive your house to work. Now, however, the $1.3tn industry — about 60 per cent bigger than it was back then — is facing an entirely different set of threats.
Not only are millions of people being put out of work, but governments are calling for everyone to stay at home to limit the spread of coronavirus. That raises questions over whether borrowers will continue to put their cars above all else when money gets tight.
Another big difference between 2008 and now: this crisis is hitting harder for those on the lower ends of the credit spectrum. The great recession created a lot of economic strife for wealthy people, but today lower wage-earning “subprime” borrowers are bearing the brunt, with the restaurant, retail and service industries being decimated, said Rosemary Kelley, head of asset backed securities at Kroll.
Given that the subprime car market was showing signs of strain before the crisis — with millions of people falling behind on their payments last year — the pandemic may create the perfect storm that bearish investors have been waiting for.
“There were already cracks in the armour. Now, with coronavirus, it’s even more downward pressure,” said Joe Cioffi, chair of the insolvency and creditors’ rights practice at Davis & Gilbert, a law firm.
That means lenders and investors in asset-backed securities could be in danger.
ABS originators typically try to build portfolios that can withstand “astronomical” levels of default, said Mr Cioffi. But this time the problem is not loose underwriting or a lack of extra protections for the top-tier investors. “No one has forecast this kind of shock to the economy,” he said.
For subprime lenders, a market dominated by non-bank institutions, the biggest problem is liquidity, said Amy Martin, senior director at S&P Global Ratings. “Right now it is very difficult to access capital markets,” she said. “ABS markets are pretty much closed.”
So far this year, nearly $26bn of auto ABS securities have hit the market, according to Finsight, a data provider. But there has been no issuance at all for more than three weeks.
This means it will be important to keep an eye on issuers’ lines of credit, which can be yanked if delinquency rates, loss rates, payment extensions or other metrics start to breach certain triggers outlined in covenants.
“We have found that companies can remain in business for a while losing money, but they go out of business very quickly when they lose access to their warehouse lines of credit,” said Ms Martin.
Credit Acceptance Corp, one of the largest of the non-bank lenders, has six warehouse lines worth a total of $1.2bn, for example, according to its most recent annual report. Since the end of January the Southfield, Michigan-based company’s share price has been cut in half. But it is unlikely that it, or any other lenders, are at immediate risk of losing these lifelines, analysts say.
It may take a few weeks before problems start showing up on lenders’ reports to investors, said Giuliano Bologna, an analyst at BTIG. Most of the people laid off or out of work since the outbreak are still likely to receive pay cheques this month so the cycle of defaults has yet to really begin. “A lot of [lenders] are receiving calls from borrowers asking for relief,” he said. “But those are things that wouldn’t flow through to the data.”
The big variables now are how well the US government’s stimulus package works and how long the crisis lasts.
With companies such as Ally Financial and Santander Consumer USA offering forbearance to borrowers, it could buy enough time to stave off widespread defaults if the economy gets back on track quickly. However, such measures may just be kicking the can down the road.
Once forbearance expires, credit performance for these companies could “deteriorate rapidly, particularly if displaced workers are unable to secure employment and businesses cannot resume operations once the economy reopens,” Fitch analysts said in a research note this week.
Unless the government gives people enough money to keep up their payments for the entire crisis, losses are bound to start piling up, said Mr Cioffi of Davis & Gilbert.
“Within two months you will see the ‘sky is falling’ talk that no one wanted to do before,” he said. “Subprime auto was sick. Now it is likely going to be in triage.”