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Dubious Honor: 1st subprime auto ABS downgrade post-crisis

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Is Honor Finance the canary in the coal mine?

Losses on its deep subprime auto loans are piling up much faster than expected and its two co-founders and chief financial officer have left. The Evanston, Ill., company, which is backed by CIVC Partners, stopped originating loans at the end of May and it is in discussions with a third party to assume various servicing functions.

Now Honor has a new distinction: S&P Global Credit Ratings has cut its credit ratings on an auto loan securitization the company completed in 2016, warning that the riskiest bonds issued in the deal are “at risk of not being repaid.” The Class C notes, originally rated BB-, were downgraded to CCC+.

It’s the first time S&P has downgraded a subprime auto loan asset-backeds since 2002, and the first downgrade of any kind of auto loan ABS since 2011.

Kroll Bond Rating Agency has the $8.86 million of notes under review for a possible downgrade.

Honor wouldn’t be the first subprime auto lender to go under since the financial crisis. At least two others, Summit Financial Corp. and Spring Tree Lending, have folded this year, after allegations of fraud or misreported losses caused their banks to withdraw funding. But the performance of Honor’s 2016 securitization indicates that the high levels credit support in these deals may not offer sufficient protection.

To date, losses on the $100 million Honor Automobile Trust Securitization 2016-1 have reached 20% — much higher than S&P had expected when it assigned a BB- rating to the Class C notes, the riskiest tranche of securities issued in the deal. The rating agency originally projected that cumulative losses, net of proceeds from repossessed vehicles, would be in the range of 20.50% to 21.50% over the life of the transaction. And the Class C notes don’t mature until November 2022.

S&P now believes net losses could rise to approximately 30% of the original receivables balance.

As of June 30, 2018, 25.38% of loans had missed at least one payment and 10.16% had missed at least two payments. S&P noted that the percentage of 60-day-plus delinquencies have been increasing since March 31, when Honor adopted “a less liberal approach to extensions,” which were 18.35% that month. (They have since fallen to 11.57%.)

“The historically high level of extensions, which we believe is outside of industry norms, coupled with elevated delinquencies, lend support, in our view, to losses being more back-loaded than normally observed in most subprime auto loan ABS transactions,” the rating agency stated in its press release.

The Class C notes benefited primarily from a form of credit enhancement called overcollateralization, which is a measure of how much the collateral exceeds the balance of the notes. This has declined to 13.36% of the current collateral balance from its required level of 20.50%.

S&P also took into consideration the significant senior management turnover at the sponsor, Honor Finance LLC, over the last seven months with the exodus of both co-founders and the chief financial officer. Honor's controller has become the interim CFO. The company stopped originating loans at the end of May and is in discussions with a third party to assume various servicing functions.

It noted that Honor “is dependent on favorable business, financial, and economic conditions to meet its financial commitments on the class.”

Despite these problems, S&P affirmed its the ratings on classes A and B, which it believes have sufficient credit support to withstand its expected remaining losses and its view of operational risks associated with the wind down of Honor's origination and servicing.

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Auto ABS Subprime lending