The auto loan-backed sector continues to garner interest from the ABS market, as there seems to be no end in sight for issuance.
Last week American Honda Financial Corp. tapped the market with a $1.5 billion deal, which was said to have priced on the tight end of talk, and there's already word of a $300 million deal from World Omni Financial Corp, which is expected to price early this week.
Ford Motor Credit, which has already brought $2.5 billion in auto issuance this year, amended its S-3 filing with the Securities & Exchange Commission last week, which suggests the issuer is ready to keep it going, save a change in market conditions.
Traditionally, in an economic slowdown, new car sales will slow down, and car manufacturers will ease production to meet demand. However, for Ford and DiamlerChrysler, increased issuance last fall wasn't tied to new car sales but rather to the cheaper funding in the ABS market compared to the unsecured corporate credit market.
"There will be more auto paper in the market regardless because the relative spreads are significantly better for the auto manufactured finance subsidiaries to finance in the ABS market versus the unsecured market," said Joseph Donovan, managing director and group co-head of asset backed finance at Credit Suisse First Boston.
So the outlook for the captive finance companies, Donovan argues, is more issuance, despite a possible decline in origination: but what of the sub and near-prime independents, such as Americredit Corp. and Onyx Acceptance Corp., where issuance does tend to more closely reflect origination volume?
Steven Tompson, a managing director at Prudential Investments, stated that nonprime borrowers are even less likely to be buying new cars in an economic slowdown.
However, in Americredit's case, used cars make up 75% of its financings. According to the company, the used car market will not slow going forward. In fact, the company is calling for between $6.5 billion and $7 billion in origination this calendar year, compared to $5.2 billion in origination for calendar 2000.
Americredit securitizes nearly all of its loans. The company has already placed $1.4 billion in auto-backed securities this year.
A slowing economy:
the credit story
The argument has been that subprime loan-backed securities, across most ABS classes, will get hit with upticking defaults going into a recession.
In a slowing new car market, however, used cars traditionally hold value better than in a booming new car market, said CSFB's Donovan.
"It's sort of a counter cyclical reality," he said. "When new cars are flying out the showroom doors, used cars take a hit. Who wants used when you can buy new?"
Conversely, when the economy is not doing as well, people tend to drive their cars longer, which dries up the used car supply.
In this sense, liquidation values (and recovery values) can be better in a slowing economy, if production and new car purchases do in fact decline.
The other perspective, of course, is that new car prices will drop, to lure buyers back into market.
"If new car prices stay flat, or decrease, there will be additional pressure on used car prices," said Amanda M. Soriano, a director at Standard & Poor's. "Also, with decreasing vehicle sales volume, and increasing competition among manufacturers to unload these vehicles, new car incentives are likely to continue being offered, which may further dampen demand for used cars."
Soriano added factors like car make and type to the mix. For instance, if there is a wave of SUVs coming off lease at any given time, then the pricing for that type of used vehicle could fall.
"In 1999 and 2000, we have seen record new car sales and leases, which may be coming to consumer market in the next few years," Soriano added.
There is also an issue as to the extent to which a car is used. The value of certified, or a nearly new car, might be affected differently by a recession than older used cars.
Regardless, some are arguing that subprime will not get hit as badly as anticipated, simply because that anticipation is based on a view of the industry as it was in the mid-90's.
"When there were problems three or four years ago in the subprime market, it was competition driven," CSFB's Donovan said. "Today the competition is much more rational. A lot of those marginal lenders are gone. It's the marginal lenders that cause loans to be originated that should never have been originated."
Over the last few years, specialty finance subprime auto issuers such AutoBond Financial Corp., Mercury Finance, Arcadia Financial, AutoFinance Group, and Aegis Consumer Finance Group have either disappeared or have been consolidated into larger, more financially sound institutions.
For example, Arcadia was absorbed by Associates First Capital (which was in turn acquired by Citigroup), while AutoFinance was purchased by Keycorp.
A larger subvened
proportion
In an economic slowdown, new carmakers will often give teaser rates and other financial incentives in efforts to boost sales, industry sources said.
This can have various impacts on the collateral in the market. These incentive rates, called subvened rates in a normal economy, are usually given by the captive finance companies to high quality borrowers, typically with Fico (Fair Isaac) scores in the 700-plus range.
"Historically, subvened has been offered to the prime and super prime type of obligor, and we'll see how that will play out in a slowing economy," said S&P's Soriano. "With increasing competition in a slowing economy, manufacturers may choose to broaden the client base that these rates are offered to."
On the other side, manufacturers will likely be aggressively marketing subvened rates to super prime borrowers, who would more likely continue buying new cars in a slow down.
"Even though they don't really think of it as refinancing, there are going to be very good deals for (new car buyers) to cash in discount autos, and then take advantage of teaser financing plans," said Pru's Tompson.
If the manufacturers do plan to target a larger portion of super-prime borrowers, will that impede super-prime business models, like PeopleFirst.com, which securitizes all Internet-originated auto loans? The company was not available for response.
