Things keep getting worse at Honor Finance.
On Monday, S&P Global Ratings put another tranche of notes issued by the subprime auto lender in 2016 under review for a possible downgrade, saying losses continued to rise over the past four months. S&P is now considering lowering its BBB rating on the class B notes. The rating agency also downgraded the class C notes issued in the deal, for a second time, to CC from CCC+.
S&P first downgraded the class C notes in July, when mounting losses reduced the level of overcollateralization, a key investor protection, to 13.36% of the collateral balance as of June 30, versus the requisite level of 20.50%. At the time, the rating agency warned that cumulative net losses could reach 30%, and these notes could incur a write off.
Since then, losses have reached some 27.2% and overcollateralization (as a percentage of the collateral balance) has declined to zero as of Oct. 31, 2018, from 13.4% as of June 30, 2018.
Investors in the class A notes appear to be in no danger of losing their principal, though they may have to put their money back to work sooner than expected. This month the trustee withdrew $1.4 million from a reserve account to pay them down; this was necessary in order to avoid a situation where the balance of then notes outstanding exceeded the balance of the collateral. The remainder of the class A notes ( just $273,000) benefit from $11.76 million subordination underneath them (98.85% of current receivables) and the reserve amount of $811,722 (3.41% of current receivables), and in any case are expected to be retired shortly.
After the draw, $811,722 (3.41% of the collateral) remains in the reserve account.
The class B notes have 40.65% in hard credit enhancement (37.24% subordination and 3.41% reserve amount).
The class C notes currently have only the reserve account of 3.41% supporting them, plus excess spread (the difference between the interest rates on the collateral and the interest rate on the notes), to the extent there is any, which will be a function of remaining losses and the timing thereof.
The report pointed to the high level of extensions that Honor has given to borrowers in the past, which S&P notes are “outside of industry norms.” Between July 2017 and April 2018, it was allowing between 15% and 22% of borrowers each month additional time to make payments. “We understand that many of these extensions may have been made to prevent accounts that were 31-60 days delinquent from rolling into the 61+ day bucket,” the report states. “In our view, such extension practices could explain why, from month one through month 14 (January 2018), the ratio of 30-60 day delinquent accounts to 60+ day delinquent accounts consistently exceeded 9x.”
This practice has been curbed since Honor’s controlling shareholder, CIVC Partners, appointed an interim CEO in April, but, as might be expected, later-stage delinquencies then started to rise.
The situation may have deteriorated further in July and August, a period of transition after Honor announced it was resigning as servicer and before Westlake took over. “In our experience, it is not uncommon for servicing performance to decline when a servicer is being replaced — presumably a function of employees having less incentive once they become aware that a successor servicer is on the way,” S&P noted. As a result, when Westlake assumed servicing, many additional accounts were rolling into default status. This, coupled with Westlake's "more standard approach to extensions," has contributed to the acceleration in losses during September and October.
“Given the rapid acceleration in cumulative net losses in September and October, and Westlake's expectation for a slower pace in November, it is difficult at this time to revise our ECNL [expected cumulative net losses], although we believe they are likely to be higher than 30%,” the report states.
