ABS platforms have varying risks to growing truck collateral exposure
A shift in consumer preference for trucks and SUVs is making investor securitizations riskier. But the risks appear to vary across various types of asset-backed platforms in the auto loan-lease market.
For years now, trucks and SUVs have become increasingly popular over typical passenger sedan cars. According to the U.S. Bureau of Economic Analysis, as recently as 2018, light-duty trucks made up 69% of new vehicle sales in the United States.
The sales figures have been reflected in securitizations of vehicle loans and leases in recent years. Ford Motor Credit, the captive finance lender for Ford Motor Co., last February added an 83.2% concentration of trucks and SUVs to its first auto-lease securitization of 2019. That compared to approximately 75% in one of its 2018 deals, and 64.3% four years earlier.
Yet the higher sticker price attached to these larger vehicles translates to a longer-term loan to pay it off, as well as higher annual percentage rates, all of which increase the potential to default in the event of a downturn affecting a customer’s ability to pay.
Michael Labuskes, a senior credit officer at Moody’s Investors Service, explained that longer-term loans are meant to keep monthly payments affordable on more expensive vehicles, like light trucks, but they do not eliminate risk for investors.
“Given the longer payment schedule and higher rates, these borrowers are more likely to have negative equity and higher negative equity in the vehicle, thus increasing severities given a default,” he said. “This slower pay-down means that the borrowers remain subject to the risk of a downturn for a longer period as well.”
A recent DBRS report agreed that borrower defaults and a higher depreciation of light-duty trucks would incur losses for those who hold bonds on the loans.
But the risks vary across various asset classes. For investors in consumer-loan ABS notes, the pools with high percentages of truck collateral could risk higher losses if consumer preferences shift in the event of rising fuel costs – affecting affordability of future borrower loan payments as well as the trucks' resale values. Lower resale values, in the form of higher depreciation, could lead to lower recoveries from the resale of repossessed vehicles.
Noteholders in dealer inventory floorplan securitizations could be impacted by dealers struggling to move inventory – which means lower profits could slow monthly payment rates in ABS deals and increase the counterparty credit risk the dealers represent to investors.
Perhaps the lease vulnerable transaction to the growing share of truck/SUV collateral are the lease securitizations from operators of commercial vehicle fleets, according to DBRS. “While corporate customers are susceptible to light-truck residual value decreases, depending on the nature of their respective businesses, the typical mission-critical reliance on light trucks would far outweigh any additional residual risk,” DBRS’ report stated. In addition, many fleet operators place the resale – or residual value – risk onto lessors through open-ended leases.
Fitch Ratings weighed in recently to note that residual values in consumer lease-car returns have actually climbed in 2019 – prompting the agency to improve its revise it market outlook to neutral on the year.
“Despite a 16% jump in auto lease ABS return volume in 2019, RV’s are recording mostly gains across auto lease ABS going into summer. The revision was driven by stronger than expected RV performance buoyed by plateauing lease returns expectations, slowing new vehicle sales, favorable vehicle return mix and strong demand for the affordability of used vehicles,” the Fitch report read.
Fitch goes on to suggest that because light trucks are in high demand and expensive, that has boosted the resale value of used cars.
Still, the demand shows no signs of going away. Even Honda, a leading passenger car seller with its popular four-door Civic and Accord sedans, saw car sales drop 9% in 2019 while SUV sales increased by 4.2%.
Auto manufacturers have responded with drastic reductions in passenger car production. Ford has killed off all of its sedan model lines with the exception of its Mustang sports car and a Focus model converted to a crossover body style from its former compact hatchback look.
“Over time, there has been a shift in the definition of SUVs with more vehicles falling into this category,” said Labuskes. “Significant improvements in mileage have also seemed to decouple (at least in part) the vehicle demand from gas prices.”