Auto Asset-Backed Securities Surge; Could Create Trouble In 2018

Auto asset-backed securities (ABS) hit a post-financial crisis high this year in the U.S., which could set up some trouble in the new year if the Federal Reserve raises interest rates and consumers struggle to pay back their auto loans.

According to a report in Financial Times, citing data from S&P Global Ratings, Wall Street firms sold greater than $70 billion in auto ABS in 2017, marking the highest amount since 2007. The report noted that demand for these securities is being driven by investors seeking different ways to make money from their investments, given the decline of corporate bonds and loan premiums this year.

The report noted that a result of the demand, the cost for borrowers with lackluster credit ratings is declining. That’s the case with Santander Consumer USA, which increased the number of sub-prime deals it issued by $2 billion to $8.76 billion.

“It seems spreads have only been going one direction this year,” said Jason Merrill, a structured specialist at Penn Mutual Asset Management. “It presents a clear opportunity to issuers to take advantage of the low cost of funds. It’s contributing to the large issuance in the space.”

Also driving auto asset-backed securities in the U.S. in 2017 was a growing demand for vehicles, which has rebounded in recent months after a slow start to the year. The majority of cars purchased in the U.S. are paid for by credit, which has created more loans that can be bundled together and sold to investors.

The report noted that the yield for the higher-rated auto ABS has also declined this year, prompting investors to go after the riskier, lower-rated securities. Those risk-seeking investors could face some headwinds in 2018, with some fearing that the auto lending market is reaching a point at which borrowers will start to struggle to pay back their loans.

Financial Times reported that if the Fed raises rates, more consumers are likely to fall behind on their loans, which could result in more delinquencies and defaults. The number of loans that have not been paid in 90 days stands at 2.97 percent as of the third quarter, which is the highest level since 2012.