Downgrades ahead for auto subprime ABS?
Ratings agencies project a tough summer for subprime auto finance.
Since the coronavirus outbreak began, the auto industry has fallen into disfavor, with all five national ratings agencies revising their 2020 outlooks on the sector and/or individual automakers downward based on a rapid decline in sales, falling values for used cars and a wave of delinquencies and forbearance requests.
But Fitch Ratings, S&P Global Ratings and Kroll Bond Rating Agency are warning that the future looks even more grim for asset-backed securities tied to subprime auto.
Fitch and S&P in the past two months revised their base-case loss scenarios and cash-flow assumptions to reflect an expected decline in receivables coming into auto loan and lease securitizations.
Kroll, on April 21, placed $1.8 billion in outstanding ABS notes for a dozen subprime auto lenders on negative credit watch, including 21 subordinate note tranches totaling $866.6 million, signaling a potential downgrade. Kroll took into account the various relief andhardship programs being adopted by – or forced onto – lenders.
“While these modifications will keep borrowers current on their loans, it could result in lower monthly collections and reduced cash flow to the securitization trusts,” Kroll analysts stated. “Some states have suspended the servicers’ ability to repossess vehicles and some servicers have voluntarily stopped repossessing vehicles altogether,” further limiting revenue for investors.
Downgrades have been rare in the sector. A $100 million 2016 transaction sponsored by defunct lender Honor Finance had the rare distinction of being downgraded – in both 2018 and 2019. But those downgrades were a result of Honor’s overreliance on forbearance programs designed to grant borrowers time to get through financial difficulties.
Currently, forbearance programs are mushrooming across the industry, and are considered a key element for consumer relief from the fallout from the pandemic.
Kroll’s actions came after Credit Acceptance Corp., a lender to car buyers with subprime credit scores, warned that it is seeing a sharp drop-off in payments as people shift their financial priorities. As unemployment soars, borrowers are putting off payments or “reallocating resources,” the company said in a recent regulatory filing.
New lending is also slowing as dealerships across the country are being forced to shutter their lots, Credit Acceptance said.
“A continued disruption in our workforce, decrease in collections from our consumers or decline in consumer loan assignments could cause a material adverse effect on our financial position, liquidity and results of operations,” Credit Acceptance wrote.
The company is among the first to report an uptick in delinquencies, while some lenders are offering forbearance.
Ally Financial, a prime lender, said in April that about a quarter of its auto-loan customers have taken advantage of its payment-deferral program.
Offering forbearance can make it harder for shareholders, investors and analysts to gauge a borrower’s ability to payments. Credit Acceptance’s filing shows some consumers already can’t keep up — presenting evidence of more trouble ahead for auto lenders.
The agencies report auto ABS losses could approach those of the financial crisis, when peak losses hit 19.02% in the fourth quarter of 2009, according to Fitch Ratings. In a March report, Fitch noted that residual gains of 5.07% of bonds tracked in its auto ABS index through the fourth quarter of 2019. Fitch rates 110 auto-loan and 21 auto-lease deals that are outstanding, making up $72 billion in notes, according to the agency.
Some new-issue ABS transactions have begun flowing new pools of loans into the securitization market, given the securities’ eligibility in the Federal Reserve’s Term Asset-backed Securities Loan Facility, notably from U.S. captive finance lenders for automakers Hyundai, Nissan and Toyota, along with used-car superstore chain CarMax.
But new subprime auto ABS deals have mostly been absent since March 11, when First Investors Financial Services’ trust priced a $186 million transaction and Hankey Group sponsored its $778 million Westlake Automobile Receivables Trust 2020-1 deal. Only Santander Consumer USA has closed a deal since, the $1 billion Santander Drive Auto Receivables Trust (SDART) 2020-1 on April 16.
Without securitization, fund availability for new- and used-car loans and leases to subprime borrowers has been substantially reduced. According to S&P, about a quarter of all subprime loans issued in 2019 were placed into ABS pools.
But lenders may not be in a position to take on new borrowers, anyway. Some have ceased originations due to the outbreak, and in a late March report S&P projected increasing stress in cash collections for existing ABS deals due to COVID-19 pressure. The overall stress will hinge on the duration of the outbreak and related recessionary trends.
At that time, record-breaking unemployment filings were just beginning, but S&P based its prediction on historical trends showing that most losses in prime and subprime auto ABS deals (55% and 65%, respectively) have occurred during economic downturns with fast-rising unemployment. (Jobless claims reached 26 million by the fourth week of April).
But losses will not be limited to loan deferrals and delinquencies.
Servicing disruptions, including delayed repossession and recoveries that reduce collections, will play a huge role. Remote working arrangements for collection staff could hamper the effectiveness of repossessions, S&P said.
The biggest impact will be on subordinate note tranches, since they are lower-rated in first-loss positions within auto ABS deal structures. S&P estimates that money-market class notes, the most senior tranche in an auto ABS transaction, would only have collections affected with at least a 50% decline in consumer-loan receivables.
S&P and fellow ratings firm DBRS Morningstar believe auto-loan securities that are speculative-grade rated – at double-B or lower – have the highest risk of downgrades. About 16% of subprime auto ABS notes rated by S&P are in those tiers, accounting for $2.8 billion of notes. Some triple-B rated notes in prime auto ABS could be subject to downgrade, but “few prime shelves issue down to the ‘BBB’ category,” accounting for only $415 million notes, S&P said.
For all the potential woes in subprime auto, the main problems seem centered on the bottom-feeder category of lenders serving borrowers with the lowest FICO credit scores, often below 600.
Kroll’s downgrade watch features notes from lenders such as American Credit Acceptance, DriveTime Acceptance Group, Consumer Portfolio Services, Carvana, First Investors Finance, Flagship Credit Acceptance, Global Lending Services, RAC King, Skopos Financial, Tidewater Finance, U.S. Auto Finance and Veros Credit.
Two issuers notably absent from Kroll’s downgrade watch for subprime auto ABS are the two biggest issuers in the space: AmeriCredit (an affiliate of General Motors and GM Finance) and Santander. Spreads on secondary market bonds for both firms’ ABS transactions actually tightened in mid-April, according to research from Deutsche Bank, indicating that investors were attracted to the higher coupons trading on the more stable tier of non-prime auto lending.
Another sign of investor-driven demand: The $1 billion SDART 2020-1 had been upsized from the proposed $750 million pool. However, Santander had to provide more support to the deal to protect investors against losses. Santander increased credit enhancement to 54.5% on the deal, compared to 52.6% on previous issues, and excluded a speculative-grade rated Class E tranche that had been part of prior deals.
Santander joined with recent prime auto ABS issuers in boosting the amount in reserve accounts that cover declines in receivables that would first impact subordinate note tranches. Santander increased its reserve account to 2% of the initial pool balance, compared to 1% in prior deals.
“We expect this trend to continue as investors and issuers alike try to get comfortable with increased usage of loan extensions in these collateral pools,” according to an April 22 report from Deutsche.
This story includes material from Bloomberg.