The automotive sector was in the spotlight last week. House Speaker Nancy Pelosi called for an emergency and limited financial assistance package for the beleaguered industry. President-elect Barack Obama also asked for immediate help for the automobile companies.
The calls for assistance came amidst negative corporate news regarding the Big Three U.S. automakers.
Shelly Lombard, senior high yield analyst with Gimme Credit, an independent research firm on corporate bonds, said that the Big Three as well as the entire automotive industry are facing problems, such as high labor and health care benefit costs, as well as a slump in sales.
However, some companies have more immediate concerns than others. General Motors Corp. (GM), for instance, might face bankruptcy in a couple of months if it does not find liquidity sources in the near term. Ford Motor Corp., on the other hand, is in a better position to handle the deteriorating economy, as it could still survive another year without having to depend on outside sources of funding, according to Lombard.
In a report, Lombard said that whether GM has sufficient liquidity to survive 2009 will really depend on how long and deep this recession will be, which cannot be predicted.
"Most economists are predicting that the market will not recover until late next year," Lombard said in an interview. "The consumer has been scared to spend. They will start spending again, but very slowly. Meanwhile, GM won't get to next year without some additional liquidity."
While GM could access the Department of Energy's $25 billion low-interest unsecured loan, approved to help various auto industry participants upgrade their facilities to create more fuel-efficient vehicles, these funds are not available immediately.
"Financing from this program is back-ended," Lombard said. "The company has to comply with certain requirements and be reimbursed afterwards. It's not the solution that GM needs. The program was approved last year when fuel-efficiency was an issue but liquidity wasn't."
Auto ABS Credit Performance
In its most recent Auto Driver's Seat publication, Fitch Ratings said that during 3Q08, prime delinquency and prime annualized net losses remained at historically high levels.
"The driver going forward is certainly going to be unemployment, causing loss frequency of default to increase on ABS auto loan transactions," said John Bella, a managing director at Fitch. "This, combined with the near-term seasonally weaker months and soft wholesale markets, will further exacerbate loss severity."
However, despite rising loss rates, rating actions have held stable in the prime segment. Upgrades continue, although at a much slower pace compared with last year. In the report, Fitch noted that the credit enhancement levels in prime auto ABS deals, especially for senior rated tranches, are sufficient to withstand this type of stress environment.
With the unemployment picture worsening, loss severity in auto ABS deals has become more of an issue.
"Severity comes into clearer focus when gas is four dollars a gallon," Joseph Astorina, an analyst from Barclays Capital, said. This has an impact on used truck prices, he added, as it dampens used vehicle valuations for this sector. Astorina noted that even though gas prices have come down to under $3 a gallon, used truck prices haven't shown much of a recovery.
There is some differentiation in the performance of prime auto collateral in terms of U.S. and non-U.S. captive securitization trusts. In a their most recent ABS Consumer Credit Monthly, Barclays analysts said that default rates for other prime trusts continue to be low relative to the Big Three, while cumulative losses remain well within historical norms in these deals.
Astorina said that aggregate performance for U.S. captive issuers has been worse compared with their non-U.S. equivalents (ie. Nissan Motor Co. or Honda) and other independents such as USAA. This is because of the non-U.S. firms' better underwriting, Astorina said. Additionally, these companies' vehicles "hold their value better when they are repossessed and have to be sold in an auction. This helps on the severity side, bringing down cumulative losses, which comprises both severity and the frequency of default."
However, the Big Three auto companies have also tightened their underwriting standards. GMAC Financial Services, for example, has recently stopped an incentive program for used-car buyers as a result of the lack of available credit. This program, which began Oct. 1 and was set to last three months, offered 3.9% financing for 60 months on certain vehicles.
"There's been a scaling back in credit," Astorina said. He added that although there hasn't been the proliferation in affordability products that was seen in the mortgage space, there has been an extension of loan terms, specifically in the 2007 and 2008 vintages.
In terms of credit performance, John McElravey, director and senior analyst at Wachovia Securities, said that auto delinquencies have certainly risen compared with the 2003, 2004 and 2005 periods, where there were low to stable default rates. Today, default rates on prime auto loans on average are double relative to the levels seen in 2003 to 2005, according to him, although even with the heightened levels of defaults being experienced currently, loss levels are still within historical ranges.
What's happening in autos is a reflection of trends in the broader consumer space. In a report, Wachovia analysts said that this credit crunch is the first serious test of the ABS market. "The recession in 2000 and 2001 was not that significant compared to what the market is experiencing right now, where there would likely be higher unemployment and a deeper recession than what we had back then," he said.
There are two things that consumers are expected to do - pull back on spending (auto sales have gone down considerably) and pay down their debt, slowing the growth in outstanding debt, McElravey said.
Auto Issuance Prospects
In terms of auto ABS issuance in the near-term, Astorina said that there has been some talk of a pretty good pipeline waiting in the wings. However, the market is in "a no man's land right now, where spreads are too wide for issuers to come to market yet not wide enough to attract investor demand," he said. "It's really a function of the current market."
"I don't see much happening unless you get a real fundamental shift in the way risk is viewed right now," McElravey said. "There's not a lot of investors taking new positions in and devoting assets to ABS and MBS. They are being extremely selective."
Despite the lack of investor appetite, the auto sector still needs securitization as a source of financing. "ABS has been an outlet for autos since 1985," he said. "The structure works well for the auto sector, and deal performance has been within issuers' baseline loss estimates."
It's certainly more expensive to issue auto paper at this point. For example, with interest rates coming back down in the past several weeks, two-year swaps are now at 2.2. With spreads for prime auto issuers at about swaps +600, the all-in yield is over 8%. "It would obviously be more expensive to issue than it has been in the past, but that's the market condition we're in right now," McElravey said. While new car sales have slowed, there's still more of a need for these companies to use securitizations to fund themselves.
Despite these advantages, however, current market conditions have dampened auto ABS issuance considerably. So far for this year, Wachovia analysts have recorded $33 billion to $34 billion of issuance volume. By comparison, $67 billion of auto ABS was issued during 2007.
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