A New Warning as Fewer Subprime Auto Borrowers Pay Off Early

(Bloomberg) -- Fewer subprime borrowers are paying off their auto loans early, a possible sign that consumers with weaker credit scores are struggling more, according to a report by Wells Fargo & Co. researchers.

Borrowers are making fewer extra payments on loans that were bundled into bonds in 2015 and 2016, compared with loans in 2013 and 2014 bonds, according to Wells Fargo analysts led by John McElravey. The data on prepayments may offer another sign that subprime consumers are having more trouble paying their bills, the analysts wrote in a note dated Tuesday. Borrowers are already defaulting on a growing amount of auto debt.

Last decade, slower monthly payment rates on credit cards were an early sign of the consumer credit cycle changing for the worse, the analysts wrote. For auto loans, slower prepayment may be more of a coincident indicator than a leading one, they wrote.

Growth in auto debt since the financial crisis has set off alarm bells on Wall Street and among regulators who are concerned that borrowers may be overburdened and used car prices are falling. Government enforcement officials have expressed concern that lenders may be making loans that borrowers can't repay, and packaging them into bonds that investors are willing to buy.

Total issuance of subprime auto loan-backed securities rose to $7.1 billion in the first quarter from $5.9 billion in the same quarter last year, according to data compiled by Bloomberg. The growth came even as losses from the debt have risen beyond levels last seen in the aftermath of the 2008 financial crisis.

The researchers at Wells Fargo, the number one seller of bonds backed by subprime auto loans, have said that the bonds pose few risks to bondholders, even though they recommend investors cut their risk exposure because of valuations. 

Slowing prepayments can hurt investors in bonds backed by car loans, said Peter Kaplan, a senior portfolio manager at Merganser Capital Management. They can result in a deal's bonds getting paid down more slowly, which can hurt the riskiest securities in a transaction.
“I think downgrades are completely possible,” with a remote possibility that the riskiest securities will take losses, he said.

Lenders and big bond graders, such as S&P Global Ratings, have pointed to the debts' fast amortization and possible upgrades as reasons for investors to have faith in the securities.

To contact the reporter on this story: Matt Scully in New York at mscully17@bloomberg.net.

To contact the editors responsible for this story: Nikolaj Gammeltoft at ngammeltoft@bloomberg.net, Dan Wilchins