CIT Group's recent financial uncertainty has raised a lot of questions about what to expect when an ABS servicer faces the possibility of bankruptcy.
Servicer risk has always been part of the ABS market, and one that is difficult to quantify, according to analysts.
The 2009 deals under its CIT Equipment Collateral (CITEC) shelf had exceptionally high credit enhancement, a result of both the economic difficulties as well as the initial rating by Standard & Poor's of 'BBB-' with a negative outlook.
Specifically, aside from higher credit enhancement, CIT also provided a named backup servicer on the 2009-VIT deal, both of which are steps that should help the current servicing on the transaction and should provide a buffer to help prevent credit losses to investors.
"The general economic environment is certainly affecting the deals, and it's clear from their performance, especially over the past few years, that those losses will be higher than what's been experienced prior to 2007," said John McElravey, senior analyst for Wells Fargo Securities. "The '09 deal is likely to be on the higher side as well, with the additional uncertainty and the effect that corporate well-being can have as an impact on the servicing of the pools."
In a recent Wells Fargo report, analysts used the CITEC shelf as a model to explore the ramifications on credit performance when the government refuses to bail out beleaguered firms. It goes without saying, according to analysts, that the economic environment has a significant impact on equipment ABS, and expected losses for the 2009 notes will be higher than what has been recently experienced.
McElravey said that, "there may be some additional volatility in ratings - more volatility than we would have seen in the past - and not necessarily due to credit performance. It may look more like corporate ratings, where those get reviewed and changed more often because you get more news coming out about the company at a corporate level."
On July 20, Moody's Investor Service placed nine ABS deals sponsored and serviced by CIT under review for downgrade. The rating agency cited increasing volatility in ratings regardless of the credit performance of CIT deals.
The rating agency emphasized that should CIT file for bankruptcy, there would be a number of effects on the current ABS under its portfolio. In the event of bankruptcy, employees tend to leave the company, causing a decrease in both motivation and workflow. This would, in turn, negatively impact the level of servicing being provided on the ABS transactions.
The chances of confusing payment schedules for borrowers are also high. There is also the possibility that borrowers might no longer pay for financing services that might not be available under a bankruptcy. Finally, funds may not be allotted correctly, or on time. It is these, and other factors, that caused Moody's to place the notes on review for downgrade. The rating agency is "focusing on and evaluating potential risks, including the potential for a sudden increase in delinquencies."
Fitch Ratings believes that while a CIT bankruptcy might result in asset deterioration, the impact on performance of outstanding ABS transactions is expected to have limited immediate ratings implications, and that CIT should be able to fulfill its servicing obligations.
The rating agency did mention, however, that delinquencies and losses should be expected with a bankruptcy filing and the agency would put CIT on a negative outlook, or downgrade the notes altogether, only if those delinquencies and losses trend significantly above relative historical data.
CIT is unique in the variety of financial services that it offers. While Wells Fargo analysts looked specifically at the equipment collateral of the vendor tech shelf, CIT also focuses on corporate, trade and transportation finance. Each of these units operates fairly independently of the others under the CIT umbrella, and therefore would be less likely to quickly impact each other should one of them file for bankruptcy. The Moody's report said that these separate divisions might not file for bankruptcy at the same time, and some might not even file at all, which would allow servicing to continue.
However, there is no one that could take over the servicing of the portfolios should the need arise, McElravey said. There is also a wide variety of obligors within the pool, so the default of one does not mean the downfall of all. Additionally, while the equipment is at a cost to the obligor, the need for the equipment is great enough to force these obligors to purchase additional default insurance for the pool, according to Moody's.
"The size of CIT and the importance of the businesses may attract people in to take over the portfolios," McElravey said.
According to Wells Fargo, looking at smaller equipment lenders, the weakness in the economy and the difficulty getting financing will most certainly have an impact on them, especially with the difficult economy causing such widespread tiering.
CIT is currently looking for additional financing from new equity investors, as well as refinancing debt, and looking for options other than bankruptcy. The firm has so far staved off bankruptcy, according to press reports, but it remains to be seen if the money was enough to carry them through.
While the financial condition of CIT will ultimately have an impact on the credit performance of the ABS deals, the more quickly CIT can resolve the issue, the lesser will be the impact. McElravey said that should CIT, for instance, undergo a restructuring in three to six months, the impact on the ABS pool would be far less than if changes to the company took longer, say upwards of a year.