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U.S. Fixed Income

Auto ABS Not a Systemic Risk

Despite more subprime delinquencies, most ABS continue to perform.

Key Insights

  • We do not view asset‑backed securities (ABS) backed by auto loans as a systemic risk to the financial system.
  • Several characteristics of the auto ABS market are distinct from the subprime mortgage market leading up to the global financial crisis.
  • Although there are areas of concern within the subprime auto ABS segment, we believe that the fundamentals of the overall car loan market remain strong.

Although recent press reports on asset‑backed securities (ABS) backed by subprime auto loans have drawn parallels to the subprime mortgage market leading up to the global financial crisis, we do not view auto ABS as a systemic risk to the financial system. At the peak of the last cycle, mortgage debt outstanding in the U.S. was more than USD 11 trillion, not including the massive amounts of related derivative exposures. For perspective, despite the subsequent boom in auto lending, the amount of auto loan debt outstanding is still only approximately USD 1.3 trillion, and related derivative exposures are much more limited.

In contrast with subprime mortgages in the mid‑2000s, auto loan underwriting standards are not deteriorating, the proportion of auto loan‑backed ABS issuance relative to new auto loans has stayed fairly stable, the percentage of all new auto loans that are being made to subprime consumers is not increasing materially, and household balance sheets are broadly healthy enough to service the higher levels of auto debt.

Rising Delinquency Rates

That’s not to say that the auto ABS market is without risk, as evidenced by delinquency rates that have been rising at a moderate rate for the last few years. Depending on the structure of a particular ABS issue, delinquencies on the underlying collateral—in this case, auto loan payments—can lead to credit rating downgrades and investor losses for some slices, or classes, of the deal. We have found value in a limited subset of higher‑quality subprime auto ABS from experienced issuers, who we meet with regularly and subject to thorough fundamental credit analysis.


1.3 Trillion

the amount (USD) of auto loan debt outstanding in the U.S.

Auto Loan Underwriting Standards Steady

There is little evidence that auto loan underwriting standards have deteriorated in recent years. This is a stark contrast with the residential mortgage market leading up to the 2008–2009 global financial crisis, when underwriting standards declined markedly and underwriters often approved loans without documentation of the borrower’s income or assets. In recent years, banks have reported that they have tightened standards on auto loans. In the auto ABS market, deals originated in 2017 and 2018 have experienced lower delinquency rates than 2015 and 2016 vintages, indicating that underwriting quality is holding steady or even improving.

(Fig. 1) Banks Tightening Standards
Net percentage (tightened minus eased) of banks tightening auto loan underwriting standards
As of June 30, 2019

Values greater than 0 indicate tighter lending standards.
Source: Federal Reserve Board/Haver Analytics.

Opening Quote In recent years, banks have reported that they have tightened standards on auto loans. Closing Quote

ABS and Subprime Lending Not Driving Boom in Car Loans

The amount of auto loans outstanding has been growing rapidly, reaching USD 1.28 trillion in the first quarter of 2019 as the percentage of Americans with a car loan climbed to 35% in 2018 from 20% in 1999.1 A higher percentage of U.S. households now have a car loan than a home mortgage, although the total outstanding balance of auto loans is a small fraction of the more than USD 12 trillion in outstanding mortgage debt.

However, the auto ABS market has not kept pace with this growth. Auto ABS issuance as a percentage of auto loan origination has stayed relatively constant since 2010, indicating that the ABS market is not facilitating the surge in auto lending. Again, this is unlike the subprime mortgage boom in the mid‑2000s, when investor demand for higher‑yielding subprime residential mortgage-backed securities helped fuel the housing bubble.

(Fig. 2) Steady Percentage of Auto Loans Issued as ABS
Auto ABS issuance relative to auto loan origination
As of December 31, 2018

Sources: Federal Reserve Board/Haver Analytics and SIFMA.

(Fig. 3) Subprime Lending Not Driving Growth in Auto Loans
Loans to borrowers with FICO score below 620 as a percentage of total auto loan origination
As of March 31, 2019

Source: Federal Reserve Board/Haver Analytics.

Percentage of Auto Loans to Subprime Borrowers Staying Steady

Along similar lines, the percentage of total new auto loans made to subprime borrowers (generally considered those with credit scores below 620–660) is not increasing. This is evidence that expansion in subprime lending is not driving the growth in overall auto loans, both prime and subprime. This contrasts with the pre‑financial crisis home mortgage market, when the percentage of new mortgages that were subprime was growing rapidly and playing a major part in enlarging the entire mortgage market.

Healthy Household Balance Sheets

From a broader point of view, household balance sheets are generally healthy, giving most consumers the financial ability to repay their car loan obligations. Household leverage is meaningfully lower than it was in 2006 and 2007, when consumers ratcheted up their mortgage and home equity debt. Household financial obligations as a percentage of disposable income fell sharply following the financial crisis and has been relatively steady since about 2013.

(Fig. 4) Household Leverage Is Relatively Low
Household financial obligations relative to disposable personal income
As of March 31, 2019

Source: Federal Reserve Board/Haver Analytics.

While we do not think the auto ABS market presents a systemic risk, subprime lending has driven delinquencies on car loans higher, with 2.36% of auto loans more than 90 days late as of the first quarter. This was the highest delinquency rate since 2012.

Although there are areas of concern within the auto ABS segment, we believe that the fundamentals of the overall car loan market remain strong. Fundamental analysis of the underlying collateral’s credit quality, as well as the structure of an individual ABS deal, is essential for avoiding pitfalls in subprime auto ABS. We have exposure to subprime auto ABS in some of our taxable fixed income portfolios, and we focus on higher‑quality issuers that have long track records.


2.36%

auto loans more than 90 days late as of the first quarter.

What We're Watching Next

A U.S. recession would cause consumer balance sheets to deteriorate, changing our analysis about the ability of individuals to meet their car loan obligations. However, the current strength of the labor market and the still healthy gross domestic product growth rate in the first quarter give us reasonable confidence that the economy will avoid a recession in the near term. A meaningful deterioration in labor market conditions would likely prompt the Federal Reserve to ease monetary policy, which could extend the economic cycle.


<sup>1</sup> Source for all auto loan market data: Federal Reserve Bank of New York.

Important Information
This material is being furnished for general informational purposes only. The material does not constitute or undertake to give advice of any nature, including fiduciary investment advice, and prospective investors are recommended to seek independent legal, financial and tax advice before making any investment decision. T. Rowe Price group of companies including T. Rowe Price Associates, Inc. and/or its affiliates receive revenue from T. Rowe Price investment products and services. Past performance is not a reliable indicator of future performance. The value of an investment and any income from it can go down as well as up. Investors may get back less than the amount invested.

The material does not constitute a distribution, an offer, an invitation, a personal or general recommendation or solicitation to sell or buy any securities in any jurisdiction or to conduct any particular investment activity. The material has not been reviewed by any regulatory authority in any jurisdiction.

Information and opinions presented have been obtained or derived from sources believed to be reliable and current; however, we cannot guarantee the sources’ accuracy or completeness. There is no guarantee that any forecasts made will come to pass. The views contained herein are as of the date written and are subject to change without notice; these views may differ from those of other T. Rowe Price group companies and/or associates. Under no circumstances should the material, in whole or in part, be copied or redistributed without consent from T. Rowe Price.

The material is not intended for use by persons in jurisdictions which prohibit or restrict the distribution of the material and in certain countries the material is provided upon specific request. It is not intended for distribution to retail investors in any jurisdiction.

© 2019 T. Rowe Price. All rights reserved. T. ROWE PRICE, INVEST WITH CONFIDENCE, and the Bighorn Sheep design are, collectively and/or apart, trademarks of T. Rowe Price Group, Inc.

ID0002441 (07/2019)
201907‑906023

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