Santander Consumer USA’s bid to improve the credit quality of its subprime auto loan originations is paying dividends. The sponsor was able to structure its first securitization of the year with fewer investor protections, potentially lowering its all-in funding costs.

The senior notes to be issued in the $1.1 billion transaction, Santander Drive Auto Receivables Trust (SDART) 2018-1 benefit from 51.4% Class A enhancement. That's a 70-basis-point reduction from the 52.1% credit enhancement for comparable tranches of its previous offering. It's also the lowest level of investor protection of any SDART transaction of the past three years, according to a presale report published Thursday by Fitch Ratings.

Both Fitch and Moody’s Investors Service expect to assign triple-A ratings to the two senior term tranches of Class A notes: $301.2 million Class A-2 notes maturing in two years and $119 million OF Class A-3 notes maturing in 2021. They also assigned their top money market ratings (F-1+ and A-1) to the $239 million of Class A-1 notes.

The capital stack also includes $182.2 million in Class B bonds rated AA by Fitch and Aa1 by Moody's; $16.6 million of Class C notes rated A/Aa3; and $119 million of Class D notes rated BBB//Baa2. A $93.1 million tranche of Class E notes will be retained in order to satisfy risk retention. Credit enhancement for each tranche has been decreased from the prior deal by between 2% and 4%, according to Fitch.

Much of the reduction in investor protection comes in the form of lower overcollateralization, which is the amount that the balance of collateral exceeds the balance of the notes. The $1.1 billion of notes to be issued are backed by $1.33 billion in loans, all of them serviced by Santander, which it originated or acquired primarily through franchised dealers. That's the lowest level of overcollateralization since Santander launched the SDART platform in 2006, according to Fitch.

The initial OC of 8% and target of 14% (with a step-down to 13% after the payoff of the Class A-2-B floating notes) compares with a 12% OC in SDART 2017-3 with a target level of 16%, with no step-down provision.

Fitch has assigned a cumulative net loss proxy of 16.5% to the transaction, the lowest of any recent SDART transaction since 2015 rated by Fitch. The rating agency cited the stable loss performance of existing asset-backed securitizations from Santander’s near-prime platform. Santander’s ABS losses have remained in the range of 12-14%, Fitch reported, “with little volatility despite weakening observed in the managed portfolio and lower used vehicle values in the past eighteen months.”

Moody's assigned a 16% net-loss expectation over the life of the transaction, down from the 17% it assigned to the SDART 2017-1 transaction that Moody's previously rated.

Repossessions are down to 16.09% in the $24.7 billion managed portfolio, while 31-60 delinquencies have lowered to 9.72% from 10.07% in late 2016. Severe late-pays over 60 days are up slightly, however, to 5.81%, but remain far below peak levels of 23.5% delinquencies in 2008.

Santander’s SDART transactions have benefited from more than just stricter underwriting. It also excludes deep-subprime originations for consumers with credit scores that the Dallas-based lender, an affiliate of the Spanish banking giant Banco Santander, has segregated into a separate trust platform (DRIVE) since 2015. The lender also has provided a loan repurchase agreement in its securitizations since last year, guaranteeing any loan that fails to have two initial payments, according to Moody's.

Santander had reduced its lending activity in 2016 as it restated of quarterly earnings three times due to accounting errors. Last October, Santander Consumer USA announced that it would boost auto-loan originations beginning in the fourth quarter, buoyed by a management changeover, an encouraging macroeconomic picture and ongoing investor demand for subprime auto loans in the asset-backed market.

The aggregate principal of the loans in the new deal is $1.33 billion from 79,166 contracts (the largest volume since SDART 2015-1). The average principal balance of $16,798 is lower than recent deals, while the weighted average FICO of 613 is the highest among SDART deals since 2015. Fewer loans in the pool (10.5%) were underwritten to buyers with no FICO scores.

Santander is placing more seasoned loans into the transaction as well, with the average loan age of 7 months well above the 2015/2016 range of 1.5 to 5.5 months for securitized loans.

By some measures, the pool of collateral is riskier. As with many nonprime and prime securitizations, Santander is bundling more longer-term loans into deals. Loans with terms exceeding 61 months has reached 91.1%, and loans with terms of up to 75 months at 10.3%. The latter is unchanged from previous deals, but only includes new-car originations from Santander’s Chrysler Capital unit that has an OEM captive-finance relationship with FCA USA (Fiat Chrysler Automobiles).

Underwriters on the deal were lead bank RBC along with BMO and Deutsche Bank. Santander, Citigroup and Wells Fargo were involved as underwriters on the Class A notes.

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