Standard & Poor’s said in a report today that it has declined assigning ratings to auto-loan securitizations from newer subprime issuers coming to market, who may not have the same level of experience or infrastructure as the more established lenders.
The ratings agency said that it is especially cautious with issuers that have short operating histories or what the ratings agency perceives “as weakness in one or more facets of their operations.”
In other cases, the ratings agency has capped its ratings on newer issuers at the 'A' or 'AA' category because increased competition in the subprime space has led to declining credit quality.
S&P also noted in the report that with the deteriorating credit quality, loss estimates are rising and credit enhancement levels have increased.
Through mid-year 2014, subprime auto ABS represented approximately 29% of the total dollar amount of retail auto loan ABS issuance. This year, S&P said it expects 16.1 million vehicles to be sold (up from 15.5 million in 2013) and approximately $20 billion in subprime auto loan ABS issuance.
Increased securitized volume would come from forecasted growth in retail auto sales and higher subprime loan originations. Investors' ongoing hunger for yield, shown in the current demand for subprime subordinated ABS, is another driver.
If the $20 billion figure is reached, 2014 would mark the second-highest year of subprime auto securitization volume. The previous peak was in 2006 when $21.6 billion of subprime auto loan ABS was issued and 16.5 million vehicles were sold.
However the growth in the space has come at the cost of deteriorating credit quality of the loans. S&P said that, based on data from Power Information Network (PIN--a business division of J.D. Power and Associates) through July 14, 2014, the percentage of used vehicles financed at franchised store locations to consumers with subprime FICO Scores (624 and lower) was approximately 25.4%, a significant increase from 2009's low of 17%.
More surprising, said S&P, is the 14% growth in the new vehicle retail sales financed to consumers with subprime FICO Scores. “While it seems counterintuitive that consumers with weak credit could afford and finance more expensive new vehicles (as opposed to used ones), finance companies are making them more affordable by offering longer loan terms of 72 and 75 months and accepting lower down payments,” the report stated. “In addition, the captives and their strategic partners are also offering incentive-rate financing”.
The weighted average LTV for the subprime pools that S&P rates has risen to approximately 115% year to date from 111.8% in 2011, 113% in 2012, and 114% in 2013. Also, 2014 marks the first time S&P saw 73- to 75-month loan terms make up 10% or more of a subprime securitized pool.
The weaker credit quality of the loans has led to some deterioration in the performance of subprime auto loans. S&P said that an analysis of 15 subprime auto finance companies, for which it rates auto loan ABS, managed portfolio losses increased 12% to an average of 6.80% in 2013 from 6.04% for 2012. The growth was modest and remained below the 7.21% average over the past 14 years (2000-2013). Losses rose a further 17% for first-quarter 2014, inching up to 7.93% (with nine of the 15 companies reporting performance).
Delinquencies jumped 21% to 8.25% as of March 31, 2014, from 6.83% a year earlier (with nine of the 15 companies reporting performance). “Rising delinquencies generally portend higher losses, which we expect for the remainder of the year,” said S&P analysts in the report.
This weaker performance has bled over to collateral losses on the 2012 and 2013 rated securitization pools. Standard & Poor's auto loan static index shows that losses are trending 39% higher for the 2012 vintage (5.45%) than for 2011 (3.93%) after 18 months.
However losses have not been high enough to impact the ratings on any outstanding subprime ABS transaction. That is because “the deleveraging inherent in sequential-pay auto ABS deals helps insulate these transactions from higher-than expected-losses, especially at the more senior rating levels,” explained S&P.
S&P also said in the report that the losses on recent vintages remain below the record-high losses of the 2007 and 2008 securitizations, “which had weaker underwriting standards in our view and were adversely affected by the recession.”
Higher credit enhancement levels on new issue auto loan also help to mitigate the risk of increasing losses. S&P said it expects the levels of credit enhancement to rise as credit continues to weaken.