Wall Street has started to see more borrowers with blemished credit falling months behind on their subprime auto loans, a potential sign of cracks in consumer credit as the Federal Reserve moves to combat inflation.
Subprime auto loans have been a surprisingly strong component of household debt over the past two years of the pandemic, helped by temporary relief from Washington that has boosted the finances of many families.
The first indicators now point to a more difficult road to travel, especially for low wages coping with higher prices at the grocery store and at the gas pump, without the Child Tax Credit or other pandemic aid to help.
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In February, the delinquency rate for subprime auto loans over 60 days past due rose to 4.15%, the highest since April 2020 (see chart below) for loans bundled into asset-backed bonds, according to Deutsche Bank.
“We are watching this very closely,” said John Kerschner, head of US securitized products at Janus Henderson Investors. “I would say, let’s see what happens in the next two months.”
Unlike last year, the round of temporary pandemic relief for homeowners, renters and distressed borrowers with student debt has now expired or is set to end soon.
“Nobody thought 2021 was going to be the norm going forward,” Kerschner said, of historically low consumer default rates and high household savings. “Everyone knew it was sort of the brave new world.”
Fitch Ratings also tracked February auto subprime ABS defaults to the highest since April 2020, albeit at a rate of nearly 4.8%.
Although February’s data is the most recent, Margaret Rowe, senior director of Fitch’s asset-backed securities group, said it was important to keep in mind that defaults for the same category were on average 5.2% in 2019, before the pandemic.
“Certainly the purchasing power of what we see on inflation could make the subprime borrower more vulnerable,” Rowe told MarketWatch. “We expected to see delinquencies normalize or return to these pre-pandemic levels.”
Why credit reports are important
Many investors have been reluctant to take on more risk this year, especially as more Federal Reserve officials call for an aggressive upward trajectory this year to help cool inflation to highs of 40 years.
The S&P 500 SPX index,
was down 5.5% on the year to Wednesday, while its energy sector was up nearly 40%, according to FactSet, pushed higher by US oil prices CL00,
above $114 a barrel.
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According to the Consumer Financial Protection Bureau. Subprime auto loan rates can range from around 10% to over 25%, a recent Consumer Reports studycompared to less than 5% for many prime borrowers.
Auto lenders often act quickly to repossess vehicles when a borrower falls behind on their payments. With used car prices up more than 40% from a year ago, the CFPB recently warned lenders not to take the plunge and illegally repossess cars and trucks.
“Any defect is going to have a significant impact on someone’s credit,” said Francis Creighton, president of the Consumer Data Industry Association, a trade group representing credit bureaus and agencies.
“If you’re subprime, you’re sinking deeper into a hole,” Creighton said by phone. He also said inflation and higher rates mean consumers “are going to pay more for virtually any type of credit” and need to get the best rate possible. “That’s why we tell people to check their credit report.”
Consumers have until April 20 to request free weekly credit reports of the three main agencies, due to the pandemic. Previously, these reports were only free once a year, a help for U.S. households who now have to a record $15.6 trillion in consumer debtt, after their balances soared around $1 trillion in 2021, the biggest annual jump since 2007.
“We believe inflation is more likely to impact subprime borrowers due to lower incomes and/or savings,” BofA Global’s strategy team wrote in a weekly note. . “This makes the subprime auto loan ABS and consumer loan ABS sectors more vulnerable to credit deterioration, which could add pressure to ABS valuations in the coming months, particularly at the subordinate level. .”
But for now, Kershner said a strong labor market helps consumers, even as rates rise and the cost of living rises. The other thing is that subordinated or “junior” subprime auto bonds, which would be first in line for losses, are not showing significant levels of stress or spread widening, indicating credit issues among investors. .
“Everything widens, but as a percentage, the top AAA classes widen more,” he said. “I would be more worried if they exploded like in 2020 at the start of COVID.”
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