Auto Loan ABS: Grappling With Elevated Used Car Values
A combination of strong demand and stunted supply has led to skyrocketing used vehicle prices in recent months. The sharp rise in prices has benefited auto loan ABS credit performance as higher resale values have boosted recoveries on defaulted loans, contributing to lower net losses across the sector (see KBRA Auto Loan Indices). However, as the economy marches toward a return to pre-pandemic norms, we expect supply and demand imbalances to gradually abate, which may negatively affect recovery rates on future defaults, leading to higher net losses.
Used Vehicle Prices Surge
Manheim and J.D. Power—two widely followed wholesale used vehicle price indices—have posted a 40% and 51% increase since February 2020, respectively (see Figure 1). This meteoric rise in used vehicle prices reflects a combination of factors that have simultaneously reduced supply and increased demand. First, new vehicle production fell significantly in 2020 because of manufacturing shutdowns and supply chain disruptions, with the latter continuing to plague manufacturers today (e.g., a shortage of semiconductor chips). Fewer new vehicle sales resulted in fewer trade-ins, which had historically been the largest source of used car supply (see Figure 2). Meanwhile, rental car companies—which are typically a reliable source of used car inventory, as they churn their fleets every few years—significantly de-fleeted in the early months of the pandemic and are now re-fleeting through the used car market to meet increased travel demand. Finally, demographic shifts and heightened aversion toward public transit, coupled with elevated consumer spending and household incomes from federal stimulus, have helped boost consumer demand.
Limited Credit Performance Benefits
Unsurprisingly, when borrowers default on their loans (and their vehicles are repossessed and sold), higher resale values translate into higher liquidation proceeds. This outcome is playing out in securitized auto loan pools, which have exhibited elevated recovery rates over the past year. Pool-level recovery rates (calculated as the total amount of liquidation proceeds divided by the total principal amount of loans charged-off in each month) reached over 90% in June, which is well above the 40%-50% historical average (see Figure 3).
However, elevated auto loan recoveries so far have been heavily influenced by lower charge-off rates in recent months (see Figure 4). This was likely because of an influx of cash to borrowers through tax rebates and a third round of federal stimulus earlier this year, providing borrowers the ability to remain current or satisfy past due payments.
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