The consumer ABS market got off to a strong start in January, with the auto sector once again leading the way. Benchmark issuers Ford Motor Credit and Santander Consumer USA kicked things off, but by the end of the month, nearly all of the auto industry’s sub-sectors, from retail auto loans and leases to rental cars, had been represented.
Nine publicly offered deals totaling $11.3 billion had priced as of Jan. 30, compared with five deals totaling $6.5 billion in for all of January 2012, according to ASR Scorecards.
Deals were heavily subscribed, even as spreads tightened, particularly among subordinated bonds. Take Ford’s $1.7 billion offering of three-year notes backed by dealer floorplan financing, which priced on
Jan. 17: The ‘AAA’ tranche priced at 38 basis points over LIBOR, a little wide of the 35 basis-point spread on the two-year, ‘AAA’ tranche of a deal priced in September 2012, but still inside the 47 basis-point spread on the two-year, ‘AAA’ tranche of a deal priced in February 2012, according to J.P. Morgan. (Ford didn’t issue any three-year floorplan ABS last year.)
By comparison, the ‘BBB’-rated three-year notes in Ford’s latest deal had a spread of 135 basis points, well inside the 170-basis-point spread on the two-year tranche priced in September 2012 and the 210-basis-point spread on the two-year tranche priced in February 2012.
Market participants say that, as shorter-dated, ‘AAA’-rated auto ABS continues to attract attention from nontraditional investors such as corporate treasurers, more seasoned ABS investors are broadening their horizons in search of incremental yield. This is fueling demand for longer-dated, lower-rated bonds.
Just 11 days into the year, J.P. Morgan revised its year-end targets for spreads. At 160 basis points, spreads on ‘BBB’ subprime auto ABS had already reached the firm’s target for mid-2013, for example. J.P. Morgan now expects its original year-end target of 135 basis points to be reached in the first half of the year, and it has reset its year-end target for ‘BBB’ spreads at 135 basis points for subprime auto loans and 65 basis points for prime auto loans.
The firm has left its spread targets for benchmark ‘AAA’ auto ABS unchanged, however. “We originally predicted a rockier start to 2013, due to fiscal cliff uncertainty and expected high-quality, benchmark ABS as cash surrogates to lead the way,” analysts Amy Size and Kaustub Samant wrote in a Jan. 11 report.
That did not happen, and the analysts now expect that growing demand and tighter spreads for higher-yielding ABS will make issuers more willing to sell subordinated tranches, rather than hold on to them.
While subordinated bonds in general are benefiting from the reach for yield, bonds backed by subprime auto loans are getting an additional boost as investors become more comfortable with a change in the way these deals are structured.
“It used to be the case that the subprime piece of the [auto] world offered some pretty rich spread, or compensatory spread for the risk, but spreads have narrowed significantly and they now offer relatively smaller pickups to prime auto paper, particularly in larger and more liquid names such as Americredit and Santander,” said David Canuel, a managing director and co-head of ABS and non-agency residential mortgages at Babson Capital Management.
Canuel, who is responsible for asset-backed strategy and analysis at the money manager, said that subprime auto ABS “had a little bit of a taint following the financial crisis, because historically the paper came on a wrapped basis and there was little or no subordination.”
When the bond insurers pro-viding this wrapper were downgraded, investors in the top-rated tranches were left with little protection, even though most of these tranches eventually did not suffer actual losses.
“Post-crisis, issuance structures came unwrapped, but with very substantial credit enhancement, both in terms of hard [enhancement] as well as typically a reserve fund and a very significant amount of excess interest,” Canuel said.
This excess interest is often enough to cover any losses that would be coming off the collateral, even in a stressed case. As a result, Canuel said, “the fixed-rate classes, particularly those with a one- and three-year average life, had a very significant amount of coverage.”
As the market has come to realize how much protection these classes have, investors have gradually bid subprime spreads closer and closer to spreads on prime auto paper.
“You’re never going to get quite where prime trades, just because the issuers tend to be smaller [than prime issuers], losses tend to be more volatile, and the issues don’t have the liquidity of prime issues. Every once in a while, you run across an issue where the excess spread is not sufficient to cover a run of bad loss months.”
This means that the subprime auto loan market tends to trade on an issuer-specific basis. “Names like Santander, which has a long record of issuance and some consistency across vintages in terms of performance, will probably get closer to prime” spreads than some other names, Canuel said.
By comparison, he said, prime auto ABS has exhibited a strong degree of consistency over time. It also has a lot of liquidity, and the issuers’ stories are well known.
Both net loss and delinquencies of U.S prime auto loan ABS decreased in November over the year-earlier period, according to the latest data available from Moody’s. The annualized net loss rate index decreased to 0.51% during November 2012 from 0.53% in November 2011. This marked the 36th consecutive month of year-over-year improvement.
However, on a monthly basis, the net loss rate increased from its October level of 0.57%. The proportion of account balances for which a monthly payment is more than 60 days late was 0.43% in November 2012, 16% lower than its year-earlier level of 0.51%.
On a monthly basis, the delinquency rate increased from 0.41% in October.
“That sector, because of its strong performance all the way through the credit crisis, really has completely recovered, in our view,” Canuel said. “On an issuance basis, it’s not quite back, but certainly on a spread basis it’s getting to pre-crisis levels.”
The size and experience of the issuer and the credit quality of the assets aren’t the only things that investors take into account, however. John McElravey, a senior analyst in the structured products research group at Wells Fargo Security, says that the market has a preference for securitized consumer assets over ABS deals that expose investors to corporate credit risk.
In a Jan. 23 report, McElravey pointed to the ‘AA’-rated tranche of the $972 million Americredit deal backed by subprime auto loans, which priced at 60 basis points on Jan. 16. That was just 5 basis points wider than the ‘AAA’- rated tranche of a $950 million deal backed by Hertz’s retail rental fleet with a similar average life. The latter deal priced on Jan. 18.
“The cash flows for the Hertz deal can be more closely linked to the ability of Hertz to manage its ongoing business risks,” the analyst noted. He said that a similar dynamic appears to be at work in the pricing of Ford’s dealer floorplan financing, which priced at relatively wide ‘AAA’ spreads compared with retail prime and nonprime auto loan deals, in his view.
The overall compression in auto-related spreads is making investors more amenable to riskier deal structures. On Jan. 16, Ally Financial priced a $1.56 million offerings with a feature that is novel for this sector: a one-year revolving period before the notes begin to amortize.