The current ABS market is reminiscent of an earlier one where issuance came from traditional sectors such as autos, credit cards and student loans.
Although issuance is not expected to surge in the earlier part of 2009, Street analysts are hoping that by 2H09, the backlog of assets that need term funding will find its way to the ABS market. Market observers believe that, despite the current consumer credit crunch, there are still securitization issuers that need to access the ABS market as a funding tool.
However, there are various factors that play into the issuers' decision to follow through with consumer ABS deals. These factors include whether there's a chance for the deal to get done considering the current all-in cost of funds. Issuers might also find alternative sources of funding outside the ABS space.
In its outlook piece for 2009, Wachovia Securities analysts projected ABS issuance in 2009 to be at over/under $100 billion. They do not expect "a more normal looking" ABS market until 2010.
The projected issuance is expected to come mostly from the credit card and auto sectors, with a smattering of student loan deals.
Looking back on 2008, Wachovia described it as a "watershed" year for the ABS market. "Price volatility, recession, weak consumer credit and suspect credit ratings drove investors from the market," analysts wrote. Meanwhile, they added that lenders responded by staying away from new deals, and new issue volume dropped to $129 billion as a result.
Analysts called the current recession the "first serious test of the ABS market." They expect that higher losses on consumer ABS transactions will mainly stem from the weak labor market. For instance, analysts are estimating that credit card charge-offs will peak at roughly 8%. Because of this, lenders are probably going to implement tighter underwriting standards and offer less available credit in 2009. Wachovia analysts added that consumers have an incentive to limit their exposure to debt. Because of this, they are expecting consumer ABS to contract somewhat in 2009, and then recover in 2010.
Consumer ABS volume will ultimately depend on whether investors are willing to risk it.
James Grady, managing director and fixed-income portfolio manager specializing in structured finance securities at Deutsche Insurance Asset Management, said that the outlook for consumer ABS in 2009 will ultimately depend upon investors' risk appetite, or whether investors are "comfortable with the product" that they are buying.
"We are undergoing a rough economic period here, and there's a lot of concern regarding the consumers and their ability to be resilient in the face of increasing job losses," Grady said, adding that these consumer products have held up relatively well from a performance standpoint, given the problems in structured finance.
Grady said that in the coming year, the market is going to see higher credit enhancement and more risk retention in deals. The real question is whether issuers will find a more attractive source of financing outside of ABS. "Spreads continue to be wide and investor participation is still limited, so you might see originators fund elsewhere, stop lending to consumers, or shrink their books, which is not positive for the economy at all," Grady said.
All About Charge-Offs
Analysts expect that deteriorating conditions in the labor market should remain a challenge for household balance sheets and maintain pressure on consumer credit losses.
Wachovia analysts are expecting charge-off rates to peak at 8% to 9%, increasing from 7% to 8%. Their outlook for charge-off rates is based on the unemployment outlook from the firm's economics group, as well as their analysis of the relationships between charge-off rates, unemployment and unemployment severity.
Grady said that there's no doubt that delinquencies are going to increase. "Typically charge-offs follow the job situation, although they will register with a lag of around three to six months," he said.
Based on further expected job losses, charge-offs will be heading higher, although there should be a corresponding increase in protection or credit enhancement in ABS deals.
"[The] excess spread, which is generally around 5% for these type of deals, is quite a bit of cushion," said Grady. "There are things originators and sponsors could do to mitigate the increase in losses, although we are under no illusions in terms of spreads -- you're pricing in the pain to come. Part of the compensation is for the liquidity risk and it is arguably justified in this environment from a purely credit perspective, although based on where unsecured spreads are trading, credit card ABS are priced attractively."
Another factor that could affect the portfolio yield on credit card ABS are the final rule
changes regarding credit card practices that the Federal Reserve and other bank regulators have issued. The new rules affect the credit card lender's ability to change rates/fees and payment allocation, among other items, and are intended to offer cardholders increased protection and disclosure.
"We believe some of the new rules will be beneficial but ultimately may result in higher APRs and fees, fewer or less attractive teaser-rates or balance transfer offers, lower credit limits, and fewer credit card offers, especially as portfolios come under increasing pressure due to the weak economy," said Merrill Lynch analysts in a report. They added that the logistics will result in the implementation of some rules before the 7/1/2010 effective date.
According to Merrill analysts' initial review of the rules, they will have limited impact on credit card ABS trusts for most of 2009. However, as the effective date of the rules gets closer, the market might see downward pressure on yields, with cardholders being given more time to adjust to changes in rates and fees. In the meantime, they said that charge-offs might improve if lenders limit offers to riskier borrowers because of reduced pricing flexibility.
Headline Risk in the Big Three
Wachovia analysts said that the chance of financial failure of the Big Three U.S. auto companies is a "stark reminder" that the ABS market is a credit market that is vulnerable to corporate headline risk.
Auto ABS pooling and servicing agreements consider the bankruptcy of the servicer an event of default. For as long as servicer default under a trust sale and servicing agreement stays unremedied, Wachovia analysts said that the controlling bondholders might terminate all the rights and obligations of the servicer. But, they said that finding a replacement servicer that actually meets the necessary requirements might prove to be difficult. In addition to this, replacing the servicer would most probably result in an even greater disruption of cash flow to the auto ABS investor, Wachovia analysts said.
Deutsche Insurance's Grady also said that credit performance in retail auto loan transactions is still in line with expectations, although there are certainly concerns regarding the possible liquidation of the Big Three. Under a liquidation, servicing on these loans would suffer and performance would deteriorate, specifically on the dealer floorplan and retail lease side. According to Grady, regarding the prime retail auto loan programs, for as long as consumers continue to pay their loans, these deals are going to continue to perform.
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