If you’re among the growing minority of investors still under the impression that  ‘everything if awesome’ in the auto industry simply because new car sales volumes continue to hover around all time highs, while turning a blind eye to soaring incentive spending and that pesky little debt bubble, then we may need your help with how we should be interpreting the following subprime auto loan delinquency stats from Morgan Stanley.

In a recent report, Jeen Ng of Morgan Stanley took a look at 266 subprime auto ABS deals to assess the underlying ‘health’ of the auto loan market and this is a recap of what he found.

First, despite low unemployment, high consumer confidence and debt-to-income ratios at 30-year lows, 60+ day delinquencies and default rates are soaring back to ‘great recession’ levels for prime and subprime auto securitizations.

Meanwhile, loss severities are also starting to rise…

….just as used car prices come under pressure…

…which likely has something to do with the flood of lease returns that are about to hit the market…

Of course, it can’t be that these deteriorating credit metrics are the result of 21 consecutive quarters of loosening lending standards from 2Q 2011 through 2Q 2016, right?

Lending Standards Have Eased…: While overall household debt remains below pre-crisis peaks, auto debt has ballooned to all-time highs. While this debt grew, the median FICO score of borrowers receiving auto loans fell roughly 30 points from peak to trough. According to the Senior Loan Officer Opinion Survey (SLOOS), auto lenders eased lending standards for 21 consecutive quarters from 2Q 2011 through 2Q 2016.

 

…but Lenders Now Appear to Be Reversing Course and Tightening Standards: While FICO scores did drop precipitously, they have recovered in recent months, and the SLOOS reports 3 quarters of tightening standards after the 21 of easing. A look at the weighted average FICO scores of loans going into subprime ABS deals reveals similar trends, with a number of lenders reporting increases in these scores over recent years. However, the overall trend has moved lower since 2013.

Meanwhile, just like in the past housing crash, the mix of “deep subprime” collateral being pawned off on the ABS market is soaring…because who else would buy it?

Shift in Deal Mix the Real Culprit: The main driver of this dynamic appears to be that, while individual lenders are increasing their weighted average FICO scores, the securitization market has become more heavily weighted towards issuers that we would consider deep subprime – those with a weighted average FICO score below 550. In fact, since 2010, the share of Subprime Auto ABS origination that has come from these deep subprime deals has increased from 5.1% to 32.5%.

 

Deep Subprime Driving Delinquencies: Since 2012, 60+ delinquencies of non-deep subprime deals picked up from 3.03% to 3.92%. While that 89bps increase certainly demonstrates deterioration, it pales in comparison to the over 300bps increase coming from these deep subprime deals.

But sure, 18mm new cars per year is probably a ‘normalized’ level of demand for the U.S. market…just like 1.3mm in new home sales was ‘normal’ in 2005.