Auto Loans

Doom with No Gloom: Forbearances Mask the Impact of COVID-19 on Subprime Auto

May 24, 2020 | By JOSEPH CIOFFI

A review of market performance since the start of the COVID-19 crisis could lead one to ponder a new existential question: Can there be pending doom, if there’s no gloom?

Earlier this month, the Federal Reserve Bank of New York released its Q1 2020 report on Household Debt and Credit and, though there was hope it would provide much anticipated insight into the impact that the coronavirus is having on the credit markets, the report itself noted that the data showed “few signs of the COVID-19 pandemic.”

Yet COVID-19 continues to have a profound effect on consumers, businesses and the global economy as a whole. U.S. unemployment claims have risen to 36 million since the start of the crisis in March. Many businesses may never recover from prolonged closures, and it is now estimated that the pandemic could cost the global economy up to $8.8 trillion.

Latest Figures

While the data largely does not reflect the current picture, it is not completely without hints. There are some early signs of trouble – particularly when it comes to delinquencies. Auto loan delinquencies, which were already alarmingly high at the end of last year, passed the 5% mark in Q1 2020 – the highest level since 2011. Similarly, 9.09% of credit card balances were 90+ days delinquent in the first quarter, representing a 6-year high. The report states that missed debt service payments may not appear as delinquencies on credit reports until a full statement period has passed, and, in reality, actual delinquency levels are likely to be significantly higher.

Similarly, in its U.S. auto loan ABS tracker for March 2020, S&P observed that 60+ day delinquencies were the worst March levels they had ever observed, but noted that while COVID-19 is starting to take a toll on auto loan ABS performance, it is still too soon to analyze the full impact of the pandemic on performance.

Where’s the Mask?

As widely reported, auto manufacturers and banks are offering temporary payment relief options for struggling borrowers. Bloomberg reported that 25% of Ally Financial’s auto loan customers have requested forbearance, and that most of these borrowers have never previously fallen behind on their payments. In fact, forbearance rates for auto loans have been accelerating and reached 7.5% in Q1 2020. In a recent webinar on the effect of COVID-19 on the U.S. auto loan ABS sector, Kroll Bond Rating Agency (KBRA) pointed out that borrower relief requests peaked in late March, but have since been decreasing. So why is the recent data not more dramatic?

The answer may lie in the Coronavirus Aid, Relief, and Economic Security Act (CARES Act). Section 4021 of the Cares Act provides that, if a consumer is granted forbearance or other forms of payment relief due to COVID-19, servicers are required to “report the credit obligation or account as current.” Therefore, forbearance programs are effectively obscuring delinquencies and we will likely not see the impact until a full payment period after the forbearance expires.

As noted by KBRA in its webinar, forbearance rates are actually higher in mortgage and student loans compared with auto loans, suggesting that consumers are prioritizing relief on the bigger-ticket items in their lives.

Potential for Downgrade

While payment relief options will allow borrowers to remain current on their loans (at least for now), the ABS market remains exposed to these hidden risks. On April 21, 2020, KBRA placed 21 U.S. auto loan and auto lease securities on Watch Downgrade. The report highlighted that modifications may result in lower monthly collections and reduced cash flow in deals. Parallels to the downgrade of the Class B and C notes in Honor Finance’s 2016 securitization cannot be ignored, in which “overreliance on forbearance programs” was cited as a significant factor in rating agencies’ decisions.

Looking Ahead

It is true that the data through March 31, 2020 only covers the very beginning of the crisis (and many prime and subprime borrowers made their payments in early March before much of the country was shutdown), and it may be some time before the damage to the secondary market comes into full view. But this aside, market participants should be wary that forbearances are skewing the data and masking the true extent of the risks in the large consumer credit markets and particularly with respect to auto loans.

Emily Hatchett, a paralegal in the Insolvency, Creditors’ Rights & Financial Products Practice Group of Davis & Gilbert, assisted with this post.