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THE LOOMING CRISIS IN SUBPRIME AUTO: WHY LENDERS NEED TO BRACE FOR IMPACT

By Jay Stone

Home / Perspectives / The Looming Crisis in Subprime Auto: Why Lenders Need to
Brace for Impact
SMARTER PERSPECTIVES: Receivables
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In the evolving landscape of the subprime auto market, a significant issue is on
the horizon, one that could have profound implications for lenders involved in
asset-backed lending (ABL) and private credit. Over recent years, the dynamics
of lease residual values have changed drastically, particularly impacting those
who deal with subprime auto portfolios. This shift is creating a potential
crisis requiring urgent attention and strategic preparation.

The Drastic Decline in Lease Security Values

From 2020 to 2022, vehicle lease security values (LSVs) were relatively stable
at approximately 40%. At that time, lenders could rely on these values as a
safety net; in the event of a default, repossessing a vehicle would enable a
significant recovery of the loan amount due to the vehicle’s retained value.
This was a period characterized by high vehicle prices, driven up by supply
chain constraints and increased demand during the COVID-19 pandemic.

However, the scenario has changed dramatically in 2023 and 2024. As a result of
rising interest rates and a corresponding decrease in vehicle prices, LSVs have
plummeted to around 20%, marking a 50% decline. This substantial drop in LSVs is
a stark indicator of the evolving risk environment within the subprime auto
sector. Vehicles, which once served as robust collateral, are no longer holding
the same value, leading to potential losses for lenders that were previously
unseen.

Factors Driving the Decline

Several factors are contributing to the rapid decline in lease security values:

Higher Interest Rates: The increase in interest rates has raised the cost of
borrowing, which, in turn, has dampened consumer demand. This reduction in
demand affects the resale value of vehicles, pushing LSVs downward.

Decreasing Vehicle Prices: During the height of the COVID-19 pandemic, vehicle
prices surged due to limited supply and heightened demand. As supply chains
stabilize and new vehicle inventories increase, used car prices have started to
decline, further diminishing LSVs.

Implications for Private Credit and Lenders

While some industry analysts predict a soft landing for the subprime auto
market, the evidence suggests otherwise. The rapid decline in LSVs could lead to
substantial challenges for private credit lenders, who have traditionally not
engaged deeply in the subprime auto space but have increasingly taken on ABL
loans. These loans, secured by assets such as vehicles, are now at risk due to
the declining values of those assets.

When lenders move to repossess vehicles following a borrower default, they find
that the assets they relied on are worth significantly less than anticipated.
This erosion in asset value directly impacts their ability to recover loans,
which can lead to cascading losses across their portfolios.

The Need for Enhanced Vigilance and Strategic Planning

Given the volatility in lease security values, lenders must adopt a more
vigilant and strategic approach to risk management. Key steps include:

 * Continued Auditing of Borrowers’ Cash Flow and Asset Values: A consistent and
   thorough examination of where lending occurs is critical in a market where
   asset values are becoming increasingly unstable. Understanding the real value
   of the assets being leveraged is essential to mitigate risk.
 * Preparation for Distress in Subprime Portfolios: As higher interest rates
   persist and vehicle values continue to decrease, subprime auto portfolios are
   increasingly likely to enter distress. Lenders should adjust their risk
   management frameworks to reflect this new reality.

How Hilco Receivables Can Provide Support

Hilco Receivables is positioned to assist lenders in navigating this complex
environment. With expertise in acquiring distressed portfolios, Hilco
Receivables offers solutions that can help soften the impact of declining LSVs
on lenders’ books. Lenders can mitigate potential losses and refocus their
strategies to better align with current market conditions by offloading
problematic assets to experts like Hilco.

In today’s uncertain economic climate, lenders who are proactive and strategic
in managing their portfolios will be better positioned to weather the challenges
ahead. Hilco Receivables can play a crucial role in this process, providing the
expertise and resources necessary to effectively manage distressed subprime auto
loans.

Conclusion: Navigating a New Reality

The subprime auto market is on the brink of significant upheaval, particularly
for lenders involved in private credit and asset-backed lending. The sharp
decline in lease security values is reshaping the risk landscape, demanding a
new level of vigilance and strategic planning. Lenders must stay ahead of these
changes, understanding their vulnerabilities and preparing to act decisively to
protect their interests.

As the industry adapts to this new reality, experienced partners like Hilco
Receivables will be critical in helping lenders manage risk and navigate an
increasingly unpredictable market.

Contributors
View Bio


JAY STONE

Chief Executive Officer
Hilco Receivables
View Bio
jstone@hilcoglobal.com email phone vcard linkedin
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