Private equity firm hedge funds hit by subprime auto loans

  • Losses on subprime auto loans are rising for private equity and hedge fund investors.
  • These investors were looking for high returns in a low interest rate environment.
  • The overall auto loan market remains quite strong, with defaults on prime loans being low.

Private equity firms and hedges are being crushed by bets on subprime auto loans.

As the U.S. auto market boomed in 2015 and 2016, setting new sales records, analysts became concerned about so-called “subprime” loans, and in particular a subset of subprime known as “deep subprime”. Because auto loans are securitized like mortgages, many comparisons have been made with the subprime mortgage crash that led to the financial crisis.

The auto market is much smaller and governed by quite different dynamics than mortgages, but that does not prevent the analogy from being imposed. But defaults on most auto loans remain modest, especially with prime loans, where borrowers have credit scores above 620.

The lower end of subprime mortgages is another story. And adventurous players such as Perella Weinberg Partners and the Blackstone Group feel some pain.

According to Bloomberg’s Gabrielle Coppola and Claire Boston: “In the years following the financial crisis, buyout companies poured billions into auto finance, chasing the big profits that come with offering high-interest loans. to weaker buyers.”

Funds took the risk to reap greater reward

Why would they take that risk? “At rates of 11% or more, there was plenty to do as sales exploded,” Coppola and Boston wrote. “But now, with demand for new cars falling, they’ve found that intense competition – and the lax underwriting standards it has fostered – is weighing on profits.”

Investment firms now find themselves stuck in the down cycle of losses and unable to extricate themselves easily.

Of course, by chasing much higher profits in the first place in a low interest rate environment, investors knew they would receive a premium for taking the risk – as long as that risk didn’t turn around.

In terms of the overall picture for auto finance, the market remains healthy despite all the subprime concerns. As sales slow, the riskiest parts of the business are most stressed. But for the most part, the financial arms of automakers and big banks have shunned subprime mortgages, giving way to less risk-averse companies.