Industry-level trends and manufacturer performance affect prepayment speeds on prime auto ABS deals, and Detroit-based manufacturers exhibit the strongest link between the two occurrences, according to Lehman Brothers analysts.
In light of the connection, investors can realistically factor in overall industry trends when estimating prepayment expectations.
"Furthermore, since bond valuation is based on three-month ABS speeds, investors should take seasonality in sales into account when pricing bonds, especially for bonds with shorter maturities," Lehman said.
In prime auto ABS, analysts said, up to 90% of total prepayments are voluntary prepayments, and most likely stem from trade-ins. Therefore an increase in auto sales, which typically trigger trade-ins, are likely to coincide with voluntary prepayments.
For the study, the bank focused on prime transactions, because it said it found a weaker link between sales and prepayments for non-prime transactions. Since non-prime transactions tend to involve used cars, they would be less influenced by used car sales. Further, defaults can represent up to 50% of total prepayments in non-prime transactions, compared to 10% in prime transactions. Therefore, trade-ins comprise a markedly smaller portion of total prepayments in non-prime transactions.
There was an interesting deviation in Lehman Brothers' results. When analyzing the correlation between sales and three-month ABS prepayment speeds for specific manufacturers, Lehman found similar results, especially for Ford Motor Credit and DaimlerChrysler. The correlation of auto sales to prepayment on ABS bonds issued by Honda and Nissan Motor Co., however, did not hold up after early 2004. Lehman speculated that Honda and Nissan's increasing market share might be the underlying cause, because an auto maker who takes market share away from a competitor can expect to see higher sales without an increase in prepayments in its own ABS trust.
If a customer is making payments to Ford Motor Credit on a loan that is in an ABS trust, then decides to trade in the car and buy from Honda, then the transaction counts as a new sale for Honda. The prepayment however, would show up in Ford's trust, not Honda's.
Announcements of major sales incentive programs are likely to cause short-term spikes in sales and prepayment speeds, especially in older deals where borrowers on the underlying loans might look to trade in their cars, said Lehman.
Because August tends to be a faster auto sales month, investors buying discount bonds in this month should find that they outperform, because sales and prepayment speeds increase over their three-month average.
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