Despite the ongoing euro area debt crisis, European auto ABS have remained a stable and active asset class with continued investor interest for standard auto assets (auto loan and auto lease receivables to private individuals and SMEs) over the last few years. Over the past 18 months, issuance in this asset class has come predominantly from Germany, France and the U.K. More recently, Norwegian and Swiss receivables have entered this asset class.
During the crisis, the major auto ABS performance indicators (i.e., 60+ day delinquencies, cumulative defaults and losses) have generally performed well, according to Moody's EMEA Auto Loan ABS Indices. In addition, investor demand has remained buoyant on the back of the relatively short average life and maturity of these transactions compared to other asset classes (i.e., residential mortgages).
The level of investor interest has triggered the re-emergence of more complex auto ABS sub-sectors (i.e., residual value, fleet lease and dealer floor plan loan securitization) and the appearance of new low-rated or unrated originators. These sub-sectors add more risk and complexity into the market than plain vanilla consumer auto financing. In addition, increased operational risk from originators/servicers with non-investment grade ratings adds a greater degree of potential volatility to a number of auto ABS transactions.
While we expect standard auto ABS to continue to perform stably, the auto ABS sector could experience increased volatility from the new sub-sectors or from elevated operational risk from less creditworthy originators.
Auto ABS performance has remained remarkably stable throughout the euro area debt crisis. Despite considerable market volatility over the past five years, ABS transactions that securitize cash flows from auto loans and auto leases for private individuals remain among the most stable asset classes in Europe. Auto ABS has remained quite resilient despite many of the top European economies being in, or recently coming out of, recession. General economic indicators, such as unemployment rates, underpin good portfolio performance, as can be seen in the German auto ABS market. German unemployment rates were low in 2011 at 6% and we expect them to be 5.5%-6.5% in 2012. Other major European auto ABS markets have seen relatively similar stability in their unemployment rates, with the U.K. at 8% in 2011 and between 8%-9% expected in 2012; and France at 9.7% in 2011 and between 9.5%-10.5% expected in 2012.
In addition to economic factors, the nature of securitized financial products has also contributed to the low volatility of delinquencies and losses in standard auto ABS portfolios over time. Private customers in many European jurisdictions are typically able to manage their loans and leases with on average three to four years maturity, fixed instalments and average financed amounts between €10,000 ($12,540) and €25,000. Many European ABS loans are also at relatively low fixed interest rates, further reinforcing the "affordability factor" for borrowers and making the sector less prone to real estate shocks or interest rate hikes.
Sixty-to-ninety day delinquencies for securitzed portfolios of loans and leases to mainly private obligors differ from country to country (see Exhibit 1). Delinquencies in Germany and France have remained stable at very low levels. A comparison of portfolio performance by originator for Germany, which has the largest number of originators, shows no significant differences among originators. Even in countries with higher delinquencies than Germany, delinquency rates have still been relatively positive with low levels of absolute delinquencies.
Operational risk rises in securitizations from low-rated originators. The low credit ratings of some originators and servicers elevate operational risk levels. As such, originators have a higher default probability and, therefore, a higher probability of causing service disruptions. European auto ABS has also seen an increase over the last 18 months of unrated and non-investment grade servicers. European auto ABS transactions have not experienced any servicer insolvencies to date. For highly rated structured finance transactions with low-rated originators, back-up servicers are generally contracted at closing to mitigate possible servicer disruptions in the event of a servicer default, although not all structures envision this. In some cases, additional mitigants include: back-up servicer facilitators; an independent cash manager; and sufficient liquidity to cover interest on the notes and costs during a servicer transition period.
The back-up servicer facilitator is responsible for finding a back-up servicer in case none is available if needed. In most European countries, the back-up servicer facilitator role is performed by an independent party that has the relevant local market knowledge to manage the back-up servicer nomination process. In France, the management company of the issuer has a more active role compared to other jurisdictions due to the securitization laws, and performs the role of back-up servicer facilitator in certain structures.
While additional structural measures will further reduce operational risk, they cannot completely eliminate it as there is limited historical data detailing the exact consequences in Europe of a servicer default. Operational risk for non-investment grade originators is reduced by the inclusion of more comprehensive measures at transaction closing due to higher default probability. Triggers in the transaction structure to introduce certain mitigating measures after a trigger breach may not be truly effective, if there is not enough time to replace the servicer before, for example, a servicer insolvency.
Complex auto ABS sub-sectors introduce new risks to the sector. While the new risks associated with each of the resurgent sub-sectors come from very different sources (e.g., market value risks, legal risks or concentrations), all three sub-sectors share a common risk factor: a higher potential exposure (or linkage) to one specific transaction party.
Residual value securitizations have a higher linkage than standard auto ABS to the originator/servicer in cases where they provide a guarantee for residual value cash flows to reduce market value risk exposure in the transaction. To reduce this linkage, we assume in our central scenario that any third-party residual value guarantee from one party (e.g., the originator) may fall away due to insolvency. As a consequence, the portfolio may then be directly exposed to market value risk (i.e., used car prices) in our quantitative analysis. This market value risk could also be partly mitigated through repurchase obligations at the end of the lease contracts from a diversified pool of car dealers that are not related to the originator in the transaction. The securitization of residual values also adds legal complexity to a securitization, as legal structures have to be very different across different European countries in order to achieve a true sale of residual value cash flows. We recently saw residual value transactions in the Netherlands, Switzerland, the U.K. and Germany.
Fleet lease products incorporate larger more diversified service packages, such as regular car maintenance and fleet management, than plain vanilla finance leases. The performance of these services is the responsibility of the originator/servicer. Any disruption in the services can trigger a lessee reaction that leads to disruptions in the securitized cash flows from the lease contracts. To delink fleet lease ABS transactions from the originator, the structures provide additional back-up solutions to ensure (i) a continuation of customer services and (ii) sufficient liquidity for additional costs that may arise during a transition phase in case of servicer default.
Dealer floor plan loan portfolio performance depends in part on the manufacturer behind the financed dealers, because a manufacturer default will hit the portfolio on multiple fronts.
Auto ABS Structures
Auto ABS transactions are similar in terms of their structure, which is often relatively straightforward. Structures today mostly use a sequential priority of payments, a liquidity reserve to provide minimum liquidity to the transaction and have no revolving periods.
Structural complexity has been further reduced, where possible, during the course of the euro area debt crisis. In the case of frequent issuers in Germany and France, the same structures have been used for a number of years, which has promoted investor awareness.
