In the newest edition of Moody's Investors Service Auto Navigator publication, the rating agency highlighted the unique characteristics of Ford Motor Credit Co.'s ABS deal launched in mid-April called Ford Upgrade Exchange Linked Notes Series 2011-1 (FUEL notes).
The $1.5 billion, five-year securitization is automatically exchangeable for Ford Credit senior unsecured notes if the company achieves an investment grade rating, according to the rating agency.
Moody's added that the offering is a positive for Ford Credit because the mandatory exchange frees the underlying pool of prime retail auto loans from the lien of the ABS bondholders, which improves Ford Credit’s financial flexibility by increasing the size of its unencumbered assets.
Issuing these types of notes also allows Ford Credit to diversify its funding mix and eventually lower its funding costs and reliance on parental support.
Moody's highlighted that this "innovative structure" combines features of both ABS and corporate bonds, which allows Ford Credit to expand its investor reach. The asset that backed FUEL is the Class A notes of Ford Credit Auto Owner Trust 2011-SRR1. Meanwhile, according to Moody's, the assets that backed the ABS notes are prime auto loans.
The FUEL notes include a mandatory exchange so that if Ford Credit achieves an investment grade rating, the FUEL noteholders will in turn exchange the FUEL notes for an unsecured Ford Credit corporate bond, Moody's explained.
Ford Credit said that the deal's main purpose is to expand its investor base as well as free up assets pledged to secure ABS notes after getting rated investment grade. Ford Credit is now highly dependent on the ABS market for funding. Encumbered assets make up around 71% of Ford Credit’s total receivables and leases at the end of last year.
High encumbered asset levels are incompatible with an investment grade rating since they limit financial flexibility, according to Moody's. For instance, it limits the firm's ability to monetize assets to generate liquidity.
Investment-grade finance firms with liquid, prime quality receivables usually have encumbered assets that comprise no more than 25%-30% of total earning assets, the rating agency explained.
To lessen its high level of encumbered assets, Ford Credit wants to diversify its funding sources. The FUEL deal, Moody's said, is the right step in that direction because it prepares the firm to remix its funding sources. If Ford issues more FUEL notes, it can make faster its funding mix transition away from ABS.
It could take the auto company some years to diversify its funding options enough so that funding costs will no longer be a hindrance to improving its credit quality. However, Moody's thinks that the firm is committed to doing so. Other constraints on Ford Credit’s credit profile have improved more quickly such as asset quality performance and profitability. With improved credit quality, and corresponding higher ratings, Ford Credit’s unsecured funding costs could materially drop, with follow-on benefits to its profitability.
According to the rating agency, by issuing the FUEL notes, Ford Credit helped limit its need for support from its parent. Ford and Ford Credit now have a similar level of credit risk, as shown by their 'Ba2' ratings.
But, Moody's said it is possible that Ford will achieve an investment grade profile more quickly than its finance unit, considering the pace of positive developments at the manufacturer and the constraining factors at Ford Credit.
Ford’s support of Ford Credit, if required, impacts the credit standing of both firms, possibly offering a lift to Ford Credit’s rating and a drag on Ford’s rating, Moody's said. The rating firm thinks that Ford management will make sure to ease the tension on the rating of the parent company that can occur due to this dichotomy such as via the issuance of more FUEL notes.
FUEL notes factor into a potential Ford credit upgrade, the rating agency said. Even though the FUEL offering's benefit depend on Ford Credit’s achieving an investment grade rating, the very issuance of FUEL notes has positive credit implications for Ford Credit.
The FUEL deal in and of itself is not helpful in terms of Ford Credit getting an investment grade rating, Moody's said. However, the deal creates a way to free up assets as well as diversify funding sources. In finding out whether or not Ford Credit can achieve an investment grade rating, the rating agency will consider that upon achieving the rating, more assets become free of encumbrance, Moody's said.