Subprime auto loan asset-backed securities (ABS) from 2022 have gotten off to a rough start. The first-quarter 2022 vintage, with 6.11% in cumulative net losses (CNLs) at month 15, is reporting a nearly 160 basis-point (bps) increase in losses relative to 2021's vintage losses of 4.53% at the same performance month. The elevated losses on the subsequent 2022 quarterly vintages, particularly second-quarter 2022, relative to the 2015-2017 vintages at the same performance month is a more ominous sign though (see chart 1).

Chart 1

Myriad Factors Have Contributed To Weaker Performance

We attribute the deterioration in 2022 performance to several factors:

• Financial benefits from COVID-19-related stimulus started to fade in 2022, with the third and last rounds of stimulus having been paid in March 2021. Similarly, advance payments under the expanded 2021 child tax credit program, which amounted to $600 a month for certain families with two young children beginning in July 2021, ended in December 2021. This supplemental income, together with existing household employment income, cushioned the large increase in vehicle prices and higher monthly payments on newly originated auto loans. The loss of the supplemental income, together with the corrosive impact of inflation (see below) on disposable income, negatively affected consumer affordability and 2022 collateral performance.
• Consumers credit bureau scores were likely inflated due to government-mandated moratoriums on repossessions and reporting of payment deferrals to the credit bureaus during the height of the COVID-19 pandemic. This "credit score inflation" may have led to loan approvals that otherwise would have been declinations.
• Inflation, which had started to rise in 2021 and peaked in June 2022 at 9.1%, continues to impact consumer finances, especially lower-income consumers given that they spend a much larger share of their income (relative to higher income individuals) on basic living expenses such as housing, food, and fuel, the costs of which were all rising at the beginning of 2022. In June, Cox Automotive undertook an analysis to determine the effective inflation rate by income quintiles, which shows that the implied consumer price inflation (CPI) for the two lowest income quintiles was approximately 22% and 12%, respectively, in June 2022. While these levels have since declined to approximately 10% and 5%, these consumers are feeling the effects of inflation to a greater extent than higher-income individuals (see chart 2).

Chart 2

• Subprime lenders increased their loan volume dramatically, with some of it coming at the expense of credit quality. Beginning in second-quarter 2021 through first-quarter 2022, there was double-digit year-over-year growth in subprime (credit score of less than 620) loan volume (see chart 3). At the same time, vehicle prices became elevated and peaked by third-quarter 2022. While the second-quarter 2022 loan volume of $35.4 billion was roughly flat with the prior year's level of $34.2 billion, it was the highest quarterly level since second-quarter 2015. A portion of the loans originated during the first two quarters of 2022 (probably the weakest in this cycle) found their way into second-quarter 2022's subprime auto loan ABS. Fortunately, subprime issuers were quick to respond to early signs of underperformance, instituting credit tightening, which, together with higher funding costs, has led to increased annual percentage rates (APRs) (or higher dealer discounts), which in turn has reduced origination levels. Subprime lending volumes began to decline beginning in the second half of 2022, with first-quarter 2023's decline of 16% to $23.4 billion being the lowest level of first-quarter originations (excluding first-quarter 2021) since 2014.

Chart 3

• Recovery rates have declined due to used vehicles depreciating again instead of appreciating as we saw from the second half of 2020 through 2021. For example, the cumulative recovery rate for the first-quarter 2022 vintage through month 15 is only 37.23%, compared to an average of 41.20% between 2015-2021, and peak of 45.56% for the 2020 vintage at the same performance month. Additionally, some lenders have indicated that they are incurring more full-balance charge-offs, in part due to longer repossession times, which some attribute to a lack of repossession agents.
• The lag between loans originated at low APRs and the significantly higher cost of funds at the time of ABS issuance in 2022--due to interest rate hikes and increased investor risk premium--compressed the spread differential, which offered less cushion to accommodate elevated net losses stemming from increased defaults and reduced recoveries.

Higher Losses Led To Downgrades, But Seniority Has Its Privileges: Some Transactions That Had Downgrades Also Had Upgrades

While the deterioration in performance has been across most issuers, those focusing on deep subprime have experienced the greatest increase in losses over historical levels and relative to our original expected loss levels. As a result, we placed our ratings on 10 non-investment-grade (non-IG) classes on CreditWatch negative this year and downgraded six of them (see table 1). We downgraded UACS 2022-5's class E to 'B (sf)' from 'BB (sf)' and all of Exeter's E classes from 2022-1 through 2022-5 to 'BB- (sf)' from 'BB (sf)'. We affirmed the ratings on ACA's 2022-1 and 2022-2 E and F classes.

Table 1

Even with the downgrades on the class E notes from Exeter's 2022-1 and UAC's 2022-2 transactions and the CreditWatch negative placement on ACA 2022-1's class E and F notes, certain senior classes on these transactions were upgraded due to the build in credit support resulting from the sequential-pay structure and build in overcollateralization (O/C) since closing. This occurred even with our expected loss levels increasing between 15% and 26%, depending upon the transaction. For example, we upgraded Exeter 2022-1's class B notes to 'AAA (sf)' from 'AA (sf)'; ACA 2022-1's class B notes to 'AAA (sf)' from 'AA (sf)', class C notes to 'AA (sf)' from 'A (sf)', and class D notes to 'A (sf)' from 'BBB+ (sf)'; and UAC 2022-2's class B notes to 'AAA (sf)' from 'AA (sf)' and class C notes to 'AA- (sf)' from 'A (sf)'. Our ECNLs for these three transactions (Exeter 2022-1, ACA 2022-1 and UAC 2022-2) were revised up to 22%, 30%, and 25.5%, respectively, from 19%, 26%, and 20.25%. These transactions did not receive sponsor support other than the servicers foregoing paying themselves servicing fees for two-to-three months.

The robust structure of these transactions is illustrated in the graphs below. In the Exeter 2022-1 transaction, as the pool has paid down, the hard credit enhancement (HCE) has grown to the greatest extent for class A, with each lower class building to a slightly lesser extent (chart 4). We then compared this to the remaining CNLs as a percentage of the current pool balance based on our original ECNL of 19% of the original pool balance (chart 5). Given that we revised our ECNL in March 2023 to 22%, we also compared the HCE to this higher revised ECNL. By dividing the HCE in chart 4 by the remaining losses in chart 5, we derive the multiple of remaining losses as shown in chart 6. Even with our revised ECNLs, the hard credit enhancement multiple of remaining losses for class B has grown to 3.4x as of May 2023 (month 15) from 2.1x at closing.

Chart 4

Chart 5

Chart 6

Charts 7-10 show how the HCE multiples of remaining losses have increased for Exeter's 2022-2 through 2022-5 transactions.

Chart 7

Chart 8

Chart 9

Chart 10

Chart 11 reflects the growth in the HCE multiples for ACA's 2022-1 transaction. Please note that the class A notes have already been repaid in full. Chart 12 reflects the growth in the HCE multiples for ACA's 2022-2 transaction. Chart 13 reflects the growth in the HCE multiples for UAC's 2022-2 transaction.

Chart 11

Chart 12

Chart 13

Upgrades Continue To Exceed Downgrades By A Wide Margin

The growth in credit enhancement feature due to the sequential payment structure and components of credit enhancement in auto loan ABS often offsets mildly higher-than-expected losses, especially for investment-grade ratings. This has given rise to the sector's long-standing track record of upgrades exceeding downgrades by a wide margin even during stressed economic periods, as shown below in table 2. From 2004 through June 30, 2023, S&P Global Ratings upgraded 2,664 classes of subprime auto loan ABS and downgraded only 21 due to credit-related reasons. During this timeframe, there were no defaults on S&P Global Ratings-rated subprime auto loan ABS.

Table 2

Related Research

• Exeter Automobile Receivables Trust 2022-5 Class E Rating Lowered And Removed From CreditWatch Negative, June 26, 2023
• Nine Ratings Raised And Three Affirmed From Three United Auto Credit Securitization Trust Transactions, May 31, 2023
• Various Rating Actions Taken On American Credit Acceptance Receivables Trust 2022-1 And 2022-2, April 25, 2023
• Various Rating Actions Taken On Exeter Automobile Receivables Trust 2022-1, 2022-2, 2022-3, And 2022-4, March 30, 2023

The authors would like to thank Liz Trick for her contributions to this article.