Standard & Poor's updated its methodology and assumptions for rating and monitoring U.S. auto ABS.
The new auto loan criteria, which are effective immediately, apply to all U.S. prime, nonprime, and subprime auto ABS loans.
Analysts reviewed and validated the calibration of their criteria based on an analysis of historical data from different sources. They also considered the agency's review of published studies; a comparison of the stress levels that they apply to other asset classes; their analysis of the relationship between net losses on auto loans and unemployment rates; and a review of actual auto loan securitization ratings performance in recent economic stress periods.
According to a report on the new criteria that the agency released yesterday, the findings of the criteria review are in line with S&P's view that auto ABS deals that are rated 'AAA' according to S&P's current criteria should be able to withstand periods of extreme economic stress on par with the Great Depression without defaulting. However, they could experience downgrades under that level of stress.
Auto loan stressed net loss assumptions are in line with the criteria calibration in other consumer ABS and RMBS after adjusting for differences in obligor, collateral and loan characteristics, the agency said. The inclusion of a cash flow sensitivity analysis is to test the credit stability under conditions of moderate stress. Analysts also started incorporating additional cash flow stress scenarios in their rating process and preliminary rating presale reports in 4Q08.
S&P incorporated this sensitivity analysis into its rating process as part of its effort to explicitly recognize credit stability as an important rating factor. By including a multipool cash flow analysis, the rating agency addressed the liquidity risk associated with portfolios containing loans with wide ranging annual percentage rates (APRs), such as high-APR loans and loans with APRs that are less than the weighted average cost of the debt issuance. These are generally subsidized low-APR loans offered by auto manufacturers' captive finance units. The agency also introduced a floor to the 'AAA' stressed case level of cumulative net losses for a pool of auto loans. The inclusion of cash flow assumptions is to incorporate prepayments in the analysis. At this time, analysts do not expect the updates to their rating methodology and assumptions to affect any outstanding ratings.
S&P's methodology for rating and monitoring auto loan ABS comprised its review of performance and pool collateral characteristics, both of which factor into the agency's base-case expected loss level for each deal that they rate.
Analysts also examined deal structures that originators apply to these securities. Via this review, they developed the set of assumptions to model based on the offering's payment structure to examine the structure's ability to pay timely interest and principal by final maturity under rating-specific stress scenarios.
The firm's auto loan ABS criteria capture the risks associated with: the credit quality of the securitized assets; cash flow mechanics and payment structure; operational and administrative risk; counterparty risk; and legal and regulatory risk.
Data presented by the agency showed the steps analysts generally undertake when rating a typical auto loan ABS. It showed the factors analysts consider when estimating base-case losses for a pool of receivables — asset quality and operating and administrative risks, which are usually more qualitative in nature — and the firm's economic and industry outlook. Once the base-case net loss level established, analysts formulate assumptions and model cash flows using stress scenarios that they believe are commensurate with the ratings and structure that are being proposed.
Analysts considered the deal's payment waterfall and structural features. They also looked at the offering's legal aspects and documentation, which include, although not limited to, a review of new SPE documents, true sale opinions, representations and warranties, and payment structure including triggers, targets, and floors.
They also do a counterparty risk analysis to see whether, and to what extent, credit risks associated with a deal counterparty could impact the transaction's rating, including the downgrade of a swap counterparty on a floating-rate ABS.
