On the Convergence of Credit Risk in Current Consumer Automobile Loans

TL;DR

This paper introduces a new statistical test for analyzing credit risk convergence in consumer automobile loans, revealing that all risk bands tend to converge to super-prime credit levels despite underwater status, with significant economic implications.

Contribution

It develops a novel large-sample hypothesis test for asset-backed securities and demonstrates convergence of risk bands to super-prime credit, providing insights into borrower behavior and lender profitability.

Findings

All risk bands eventually converge to super-prime credit.

Borrowers forgo $1,153-$2,327 in potential savings.

Results are robust to COVID-19 impacts.

Abstract

Loan seasoning and inefficient consumer interest rate refinance behavior are well-known for mortgages. Consumer automobile loans, which are collateralized loans on a rapidly depreciating asset, have attracted less attention, however. We derive a novel large-sample statistical hypothesis test suitable for loans sampled from asset-backed securities to populate a transition matrix between risk bands. We find all current risk bands eventually converge to a super-prime credit, despite remaining underwater. Economically, our results imply borrowers forwent \$1,153-\$2,327 in potential credit-based savings through delayed prepayment. We present an expected present value analysis to derive lender risk-adjusted profitability. Our results appear robust to COVID-19.