Used-Car Dealer Debuts Subprime Auto Bond Even as Sector Weakens

(Bloomberg) -- A car dealer that caters to buyers with checkered credit histories sold asset-backed bonds for the first time ever this week, joining a surge of such sales even while delinquencies rise industrywide as surging inflation hits low-income Americans. 

America’s Car-Mart, a used-car retailer focusing on the U.S. South and West, priced its first subprime auto ABS on Thursday, the latest of a string of similar bonds still garnering relatively strong demand from money managers despite rising delinquencies and losses on overall subprime auto loans. The $400 million transaction received a grade of AA- on its senior-most tranche from Kroll Bond Rating Agency and risk premiums on several slices widened out at pricing from guidance levels, signaling the firm likely had to pay a concession to investors as a first-time ABS issuer.

Subprime auto bond issuers have been racing to the market as the highest inflation in 40 years is expected to impact the lowest-income borrowers the most as pandemic-era stimulus programs simultaneously come to an end. 

While investors have taken notice of stresses, many of them are still buying the securities, which are notoriously well protected with various credit enhancements and safeguards and offer the benefit of short duration, which lessens the impact of rising interest rates.  

“Some of the pricing we’re seeing up and down the capital stack on these types of deals is significantly wider compared to the second half of last year, but you’re still seeing fairly strong execution levels,” Daniel Lucey, senior portfolio manager at SLC Management, said in a phone interview, referring to the broader auto ABS market. “With rising inflation, there is certainly pressure on lower-income consumers, but the structuring of these subprime auto ABS is extremely robust.”

America’s Car-Mart focuses on both the sale and financing of vehicles to subprime borrowers whose FICO scores are 620 and below, according to a report from Kroll.  The transaction’s loan pool has an average FICO score of 553, an average current principal balance of $11,167, an average interest rate of 16.39%, and average original maturities of about 3.4 years and remaining terms of 2.7 years, according to Kroll. The collateral is comprised of 100% used vehicles.

“This is one of those deals where you definitely have to do the work,” said John Kerschner, head of U.S. securitized products at Janus Henderson Investors.  “But we think you are getting compensated for the risk, and it’s a public company, which is always helpful.”

Spreads on auto ABS have generally been softer this year due to broader financial market volatility, including Russia’s war in Ukraine and the Federal Reserve’s moves to tighten monetary policy.  But some tranches of the America’s Car-Mart deal widened beyond the initially expected levels and those on similar transactions from other issuers with a longer track record in the asset-backed securities market.

The senior-most AA- slice with a short 0.37-year maturity priced with a coupon of 3.23%, or 220 basis points over a benchmark, which was 10 points wider than anticipated price-guidance levels. The BB- tranche priced 100 basis points wider than suggested guidance levels at a 8.58% coupon, according to data compiled by Bloomberg. On the other hand, a slice rated A- priced on the wide end of guidance, and a BBB- tranche landed at the tighter end of guidance.

Even though the deal had comparably shorter paper than peers -- which is usually more attractive to investors -- risk premiums were wider for some ratings tiers compared to other recent subprime auto ABS issuers, data show. A slew of subprime deals have priced in recent weeks, including bonds from Consumer Portfolio Services, Exeter Finance, Arivo, Veros, and Santander Consumer USA.  Another company, Automotive Credit Corporation, has begun premarketing a transaction for next week. 

The share of securitized loans in subprime auto ABS that have been delinquent for more than 60 days increased to 4.20% in March versus 3.60% a year earlier, although they decreased from 4.68% in February, according to Barclays Capital data. Annualized net loss rates increased to 4.95% from 4.72% a year earlier.  However, the delinquency numbers were slightly higher in 2019 pre-pandemic, and the recent change is seen as returning them to more typical levels.

Despite some losses in the subprime auto ABS loan pools, bond investors rarely see a loss on these types of securities, investors say. That’s because issuers bake in strong credit protections to insulate them from losses. Many lower-rated slices of subprime auto bonds actually get upgraded as the bonds pay down and cash flow is diverted to cover loan losses.

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