A second credit rating agency has downgraded subprime auto loans issued by Honor Finance, the Evanston, Ill. Lender that lost much of its senior management over the past seven months and stopped originating loans in June.

Kroll Bond Rating Agency on Tuesday cut its rating on the riskiest notes issued in the deal, the Class C notes, to CCC+ from BB-, saying the notes are at “substantial risk of loss” given the current situation. Kroll’s original rating for the notes was based on expectations that losses on the loans used as collateral for the $100 million deal would not exceed 21.5% of the original balance of the collateral. It now expects that net losses will reach between 31% and 33%. At that rate, the Class C notes, which had an original balance of $8.86 million, would incur losses of between $2 million and $4 million.

In other words, investors in the Class C notes could lose nearly half of their principal.

The downgrade comes a week after S&P Global Credit Ratings took a similar action on the Class C notes. S&P expects losses on the collateral to reach approximately 30% of the original receivables balance.

Kroll went a step further, however, putting the more senior Class B notes under review for a possible downgrade. It has the senior Class A notes on “watch developing,” but currently expects that investors in this tranche will likely be repaid, given the level of protection it enjoys.

Since Kroll put the Class C notes under review in May, outlook has only worsened. Cumulative net losses have increased by 2.36% to 20%. As a result, the amount of excess collateral available, an important safeguard for investors, has decreased to 13.36% of the balance of the outstanding notes, which is well below the target level of 20% and its lowest level since the deal closed.

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Another form of credit enhancement, the non-declining reserve account, has increased as a percentage of the current collateral balance and is currently 6.14%, however.

And now that Honor is stepping down as servicer, there is the risk of potential disruption in payment collections during a transfer to a new servicer, according to Kroll. The rating agency is concerned that a majority of borrowers who are currently behind on payments or have obtained an extension will eventually default.

Honor was formed in 2001 and is majority-owned by CIVC Partners, a private equity firm based in Chicago. Unusually for a first-time issuer with a limited track record, it was able to borrow heavily against the collateral in its December 2016 securitization, issuing notes rated as low as double–B by both S&P and Kroll.

Initially, the collateral performed within the rating agencies expectations, but from the January 2018 to March 2018 collection periods, cumulative net losses increased significantly, in part because Honor ecategorized liquidated receivables as defaulted receivables.

In addition, according to both rating agencies, Honor has been granting borrowers more extensions than other subprime lenders. However, the company has recently revised its extension policy to make it more industry standard. The current extension rate is 11.57% down from a high of 21.94% in January 2018, according to Kroll.
Kroll’s report provided some additional details about problems at Honor. The rating agency noted that CIVC Partners decided it would not contribute any further equity into the lender.

Honor has also breached a loan covenant, resulting in a servicer termination event on its warehouse facility with Wells Fargo and the facility is amortizing. As of June 30, 2018, the facility has approximately $172 million outstanding, per Kroll.

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