Credit unions, some of the most careful auto lenders, may soon have the ability to securitize these loans.
The National Credit Union Administration (NCUA), has proposed a rule allowing federal and some state-chartered federally insured credit unions to create special purpose vehicles to hold assets. This would enable federal credit unions that can meet certain requirements to securitize loans they have originated. Market players say that the law isn’t likely to pass before the end of 2014, however.
Although the proposed rule applies to all loans financing residential real estate, automobiles and credit cards, Moody’s Investors Service expects that auto loans are the most likely asset to be securitized. Auto loans have been credit unions’ fastest growing asset class for two straight years and are the most widely offered product.
The proposed rule could make auto loan securitizations an attractive way for these financial organizations to maintain this growth, according to Moody's.
Under the rule,qualified federal credit unions would be able to securitize loans if they meet certain criteria approved by the Board. A credit union would be required to create a separate, special-purpose entity to hold the assets. It would also need to have independent risk-management controls and an annual independent audit performed.
Additionally, the credit union’s board members would need to have an adequate understanding of the securitization process, and senior management would need to have sufficient expertise to oversee these transactions. The credit union must also have in place a board-approved securitization policy.
Mary Dunn, SVP & Deputy General Counsel of Regulatory Affairs at Credit Union National Association, said that, if adopted, the rule would only apply to federally insured, state-chartered credit unions, however “a number of states allow their institutions to engage in similar activities if the federal credit unions are allowed to do something. It is possible that this rule will directly impact federal and indirectly impact some state funded credit unions.”
While securitization could be an effective tool for very large credit unions that have the capacity and expertise to handle these transactions, the costs of compliance may keep some player out of the game.
Dunn expects that initially the scope of the market will be limited by a credit union’s ability to jump though “the hoops it’s going to take to actually establish a securitization program”.
“As the credit union system becomes larger and more complex, more credit unions are developing the scale and expertise to offer sophisticated innovations,” said NCUA Board Chairman Debbie Matz.
As of the end of the first quarter of 2014, new car loan holdings for Federal credit unions stood at $73.5 billion, a 3% increase from the fourth quarter of 2013 and about 14% over the first quarter of 2013, when it was $64.6 billion according to the NCUA.
Holdings of used car loans stood at $130.2 billion in the first quarter, an increase of 2.2% increase from Q4 of 2013 and an increase of a little more than 11% from Q1 of 2013, when it was $116.9 billion. NCUA calculated figures based on 6, 491 credit unions reporting.
In 2013, auto lending by credit unions grew by 12.7% for new cars and 10.5% for used cars according to trade group Credit Union National Association.
Among all auto lenders, credit unions posted the second-highest portfolio growth from first-quarter 2013 to first-quarter 2014, increasing their market share to 16%, behind the banks’ 35% and the captives’ 26%, according to Experian.
The credit quality of the loans underwritten by credit unions is a good fit for securitization. According to Moody’s, credit unions have slightly higher concentrations of prime and super-prime quality customers which correspond to FICOs of 740 plus for super prime and 680 to 739 for prime borrowers - than their bank and captive finance peers. First Quarter 2014 figures reported by Experian shows that super prime borrowers make up 28.5% of credit union lending and prime borrowers make up 24.7% of lending.
There is less of a focus on the subprime sector, which has come under scrutiny by the U.S. Department of Justice. The DOJ has subpoenaed General Motors and Santander Consumer USA about their lending and securitization practices.
According to Experian, subprime lending —which are borrowers with FICOS of 550 to 619 — makes up 14.2% of overall auto lending for credit unions.
To date, performance has been strong. Credit unions have the lowest repossession rate among auto lenders, 0.15% for first-quarter 2014, compared with 0.24% for banks and 0.35% for captives, according to Experian. They also have the lowest 30-day and 60-day delinquency rates among the major lender types, 1.20% (versus the banks’ 1.93% and the captives’ 2.23%) for 30-day delinquencies and 0.32% (versus 0.55% and 0.43%) for 60-day delinquencies in first-quarter 2014.
While the proposed law enabling credit unions is not likely to take effect until 2015, Moody’s is already considering an appropriate methodology for rating any future deals.
In its report it stated that, because credit unions have not securitized their auto loans in the past, it plans to establish appropriate loss protection levels based on a credit union’s ABS collateral pool and managed portfolio characteristics, structural features including triggers, transaction governance and oversight and the alignment of interest with those of auto ABS investors. “If credit unions opt to use the securitization markets, we will benchmark their servicing history and performance against their bank and finance company peers to establish appropriate loss protection for investors,” the report states.