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Private Equity Money Could Fuel Higher Credit Losses for Subprime Auto

July 09, 2013

NEW YORK — Stiff competition for market share, weakening loan credit and an active asset-back securities market were reasons listed in a new report from Moody’s Investors Service that predicts higher credit losses for subprime auto lending.

The report, “Risk Factors Still on Rise for U.S. Subprime Auto ABS,” echoes conclusions stated in a report issued last year by the ratings agency. But this year’s report also lists the availability of more private equity money as a major contributor to rise in risk in the subprime auto finance segment, with Moody’s stating in its report that private equity money if further intensifying the competition from banks and credit unions.

"The increased competition among subprime lenders is resulting in more loans to borrowers of weaker credit quality," said Peter McNally, a Moody's vice president and co-author of the report. "The credit weakening has been gradual so far, so losses won't spike immediately. But more borrowers are going to default eventually, as originations continue to grow."

Subprime lending volumes, which bottomed out in 2009 in the wake of the financial crisis, have more than doubled since then.

The ABS market's strength also increases competition among lenders because it facilitates lenders' desire to grow and increase market share. Investor appetite for subprime auto ABS has allowed issuers to offer increasingly lower spreads on senior bonds and back a growing number of transactions with prefunded loan pools, a trend that will weaken credit in securitizations because these loans are unseasoned.

"A more precipitous weakening in credit quality will drive losses up more quickly to levels that will stress lenders' servicing ability and may eventually threaten their solvency," added McNally. "If that happens, originator failures can cascade quickly because their funding sources will pull back when they lose confidence in the market.”

To download the report, click here.

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