Auto loan market is shifting back to normal

The auto loan asset-backed security (ABS) market is experiencing a shift characterized as "normalization" rather than deterioration, despite increased delinquency and charge-off rates since mid-2021. This trend is primarily attributed to the subprime sector, particularly among its weaker participants, while the overall credit performance remains structurally sound. During the Covid-19 pandemic, delinquencies and charge-offs were at historic lows due to government stimulus and reduced consumer spending, but recent inflation and relaxed underwriting standards have impacted subprime vintages from 2022.

Smaller, less-capitalized subprime issuers are experiencing the most significant challenges, with larger issuers, typically supported by banks and auto manufacturers, demonstrating resilience due to their robust origination platforms and diverse financing options. Despite these challenges, ABS deal structures continue to show strength through consistent overcollateralization and ample reserve accounts. The excess spread remains a strong defense against charge-offs, with some tranches tested to withstand severe financial scenarios.

The market has seen a surge in new auto ABS issuances, indicating growth and presenting attractive investment opportunities. These deals are often oversubscribed, reflecting strong market demand. However, potential risks such as rising unemployment and declining used car prices could exacerbate delinquencies and charge-offs. Investors can capitalize on these opportunities through diligent credit investment analysis, allowing them to navigate the market effectively despite the normalization in delinquencies.