Chips are down but auto ABS opportunity is up
Semiconductor shortage is an all-around positive for these asset-backed securities.
The auto asset-backed security market is a strong component of the asset-backed securities (ABS) market—roughly half—and is in turn a key component of short duration fixed-income strategies, including ultrashort strategies. With automakers, car dealers and consumers enduring vehicle shortages due to supply chain shortages (particularly semiconductor chips), it’s inevitable the auto ABS market would feel an impact. Although the car supply crunch would seem to be a negative for auto ABS, it actually has delivered a benefit in the form of higher prices, especially used car prices. As auto sales have plunged—Cox Automotive estimates used vehicle sales were down 13% year-over-year (y/y) in September while new vehicles sales plummeted 25%—prices have soared. Cox estimates new car prices have risen 10% y/y while the Manheim Used Car Index, a measure of wholesale used vehicle prices, is up more than 27%.
Lower car supply and higher prices support both the auto loan and lease markets and, ultimately, auto ABS. Here’s how:
- Thanks to the current supply/demand imbalance, if someone defaults on their car loan and the car is repossessed, the loan servicer can now garner a higher price for the car at auction. This reduces net cumulative losses on the auto ABS loan deal. With that said, it’s also the case that auto loan defaults have been mitigated thanks to expanded unemployment benefits, government stimulus payments and loan forbearance programs related to Covid-19 relief—another support for auto ABS. We expect only moderate increases in delinquencies and defaults for auto ABS as loan contract extensions expire and payments come due, and as federal aid to individuals diminishes.
- Like auto loans, leases carry default risk. But unlike loans, they also are subject to residual risk. This occurs if the car’s value stipulated in the lease agreement ends up being more than its market value when the lease term ends—typically after three years. For an auto lease deal, 60% to 70% of the securitization value lies in its residual value. Again, thanks to car shortages and high used car prices, more people are deciding to purchase their leased vehicles instead of turning them in. This benefits auto ABS because of the reduced residual risk. Even when leased cars are turned in, the residual risk is greatly reduced because of the high prices these used cars now command, which generate residual gains instead of losses for the auto ABS lease deal.
Auto ABS issuance year-to-date totals $106.8 billion, versus $98 billion for all of 2020. Prime auto ABS is down slightly due to the new car shortage, but lease is up to $25.8 billion year-to-date, ahead of full-year 2020’s $19 billion. The boost to auto ABS’ overall credit quality has resulted in strong demand, tighter credit spreads for the asset class relative to comparable maturity Treasury securities and outstanding collateral performance. So, while the auto industry and consumers are feeling the pain of this dearth in car availability, investors in the auto ABS market continue to benefit from a distinct silver lining.