Subprime Auto Performance Looking Subpar

September 15, 2016

Subprime Auto Performance Looking Subpar Photo

After the financial crisis, consumer and mortgage credit contracted sharply as lenders and regulators grappled with the new credit landscape.  Regulators sought ways to curb underwriting slippage to prevent future bubbles from forming.  The natural byproduct of this increased regulation and added scrutiny was for underwriting standards to become so stringent that many borrowers no longer qualified for mortgage and automobile loans, which were more easily accessible before the crisis.

Seven years later, mortgage credit underwriting standards remain very tight, but consumer credit for autos and credit cards has loosened materially.  The lenders are of course aware of the added risk associated with expanding the credit box, and they have the ability to charge higher interest rates in order to offset those associated risks.  However, historical delinquencies and losses in subprime auto lending for more recent vintages suggest that underwriting has slipped to a point where the risk profile of the sector is starting to deteriorate.

Key Takeaway: In spite of the strong technicals present in the credit markets, increasing subprime automobile loan delinquencies are a cause for concern.  As subprime credit lending standards have eased, sector performance has started showing signs of weakness.  Securitized credit backed by autos has long been considered a cash surrogate due to the outstanding liquidity and deal structures in the sector.  However, the recent weakness in sector performance should cause credit investors to think a little more deeply regarding underwriting quality as they choose how to be involved in the sector.

Tags: Chart of the Week | Credit | U.S. economy | Credit spreads | Subprime credit

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This material is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management.  This material is not intended to be relied upon as a forecast, research or investment advice, and it is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy.

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