It’s no secret that subprime auto loan risks have been rising and default rates remain high, but thus far that fact does not seem to be bothering investors. In fact, it appears that the subprime auto loan bond market is currently doing brisk business at least in part because of tight spreads. What does this mean for BHPH dealerships?
For those unfamiliar with the term, a tight spread refers to when the difference between bids and asking prices are narrow, usually driven, as it is in this case, by high competition. This, coupled with energetic and eager trading in the subprime auto loan bonds market, is continued evidence of investors’ willingness to adopt greater risks in the current economic climate.
Of course, subprime auto loans are hardly the only kind of debt on the rise. Many other areas of consumer lending, such as student loans and credit cards, have seen increases in debt recently. This begs the question: what is tightening the market for subprime auto loan bonds specifically making this particular market so attractive to investors?
Fitch Ratings analysts reported in late June that this may in part be due to used cars’ relatively high residual values and lenders’ application of stricter credit standards. Add to that the fact that 60-day subprime auto loan delinquencies, while still high, have declined to 4.08% from a staggering 5.8% in February, and it is easy to see why the market currently appears more stable. All of this creates an illusion of lower, or at least more controlled, risk.
Nonetheless, there are still risks. Wells Fargo analysts pointed out the danger of buying up these potentially lucrative subprime auto loan bonds too freely. Valuation risks and spread volatility could still prove to be future problems. Thus, according to the analysts June report, investors must be selective and prudent when adding these bonds, seeking out the best available issuers.
All of this means two important things for BHPH dealers. First, the tightening of the market means that subprime auto loan bond sales are still both high and competitive, and are likely to remain so for some time. This in turn means that other lenders and financing companies will continue to make forays into the BHPH industry, causing greater competition for lendees. Second, it is vital to remember that some economists still have concerns about the current subprime auto loan bond market. As a result, BHPH dealers should focus on keeping current customers sold as well as on acquiring new customers. Dealerships should be reasonable in the financing terms they offer, matching rates to risks, and should be realistic when considering how much car a customer can afford. All of this will help to protect the dealer and their assets should the market take a sudden fall.