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Survey indicates growing worries in subprime auto ABS deterioration

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A new survey among participants in subprime auto-loan securitizations show widespread concerns that the asset class will suffer deteriorating performance in the near future.

In a study published Tuesday on a microsite of New York-based law firm Davis & Gilbert, a poll showed at least 60% of investors, issuers, trustees and servicers all expect the performance of subprime auto loans “to deteriorate soon.”

The respondents overwhelmingly believe that the worsening performance of the loans will require more credit enhancement by issuers, and will likely lead to downgrades in auto-loan securitizations that have been few and far between in the post-crisis era.

“Such gloom is noteworthy given the lack of pain in most participants’ past experience in subprime auto,” stated the report on Credit Chronometer, a microsite authored by Davis & Gilbert partner Joseph Cioffi.

The study included a first-time polling of the different constituencies within subprime auto-loan securitizations, and included some distinct outlooks on risks and expectations on issues such as credit enhancement levels and credit ratings on forthcoming deals.

“There’s a disconnect between history and what’s going forward,” Cioffi said in an interview. “Everything’s been good in the past but there are expectations going forward that it might not be as good.”

The first-time poll of 100 participants conducted by the firm’s microsite (Credit Chronometer) in February found that 79% believe credit enhancement levels will likely need to increase to obtain desired ratings – with 86% of investors in the poll agreeing with that sentiment. The investors “are more concerned than any other group about subordinated tranches,” with only 57% believe CE levels will be sufficient to cover the lower rated notes.

The recent second downgrade of the subordinated notes of a 2016 securitization by defunct lender Honor Finance was foremost on their minds, Cioffi noted, with at least one-third of respondents believing that servicers and issuers will rely more heavily on credit extensions to borrowers.

Payment extensions were at the center of the problems for Honor, which had high delinquency and default rates that critics contend were initially masked by a high rate of payment holidays granted borrowers. Over 22% ofHonor's deep subprime account holders had one or more extensions on their loans, according to S&P Global Ratings.

The outlook on that trend is viewed differently across the different groups in the survey. The polling showed one-third of the respondents believe that originators and servicers will rely more on credit extensions in the next one-to-two years than in the past. “Originators believe most strongly that credit extensions will have a positive impact on performance,” which allow borrowers to get past rough patches and regain current status in delinquent loans, the report stated. “Investors and others are much less certain that the effects will be positive.”

Although downgrades have been rare, credit ratings may also be stressed by deteriorating performance, the report warned. Over 60% of originators, trustees and services said the Honor Finance downgrades will have a “very or somewhat significant impact on their decisions regarding subprime auto securitizations” going forward, with 46% believing that delinquencies will be the main cause of future credit ratings downgrades.

Downgrades could be a significant factor on trustees’ participation in the market, Cioffi said. Trustees are already worried about the impact of volatile credit ratings to their business, potentially exposing them to legal entanglements with investors (similar to trustees’ post-crisis experience in residential mortgage-backed securities).

“You’re seeing some concern here that as the market weakens, what does that mean in terms of their ability or desire to keep participating in the deals?” Cioffi said of the trustees handling subprime auto ABS deals. “It may affect pricing, it may affect the documentation in terms of how strong their exculpation clauses are."

Cioffi added that “if they continue to participate, I think those are two areas [where] they’ll look to tighten their own obligations, their responsibilities and protections and their costs as well.”

Issuers, the report stated, “should expect higher credit enhancements will be necessary going forward – not only to obtain desired ratings, but also to maintain investor demand.”

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