Testing a Novel Structure for Auto ABS

Concerns about deteriorations in underwriting criteria haven’t stopped investors from signing on to auto loan securitizations that allow sponsors to add new, and potentially riskier, loans to the pools of collateral at a later date.

In January, Ally Financial issued a $1.56 billion deal with a revolving structure that allows proceeds from loan payments made during the first 12 months of the transaction to be used to purchase additional loans.

Also in January, Santander Consumer USA priced a $1.25 billion auto loan securitization with a pre-funding account. Some $202 million of the proceeds were set aside for the purchase of additional collateral at a future date.

Both deal structures introduce new risks, because any loans added to the pools could be riskier than the ones originally securitized. That is no small concern, given that increased competition among lenders is leading them to make loans with longer terms and lower down payments to borrowers with lower credit scores.

In Ally Financial’s deal, new loans can be added for 12 months after the transactions close; in comparison, Santander Consumer’s deal allows new loans to be added for approximately one month after the closing of the transaction.

A revolving structure is rare for retail auto loans; it is more typical of deals backed by the cars on dealership lots or by credit cards, in which the receivables are constantly turning over.

In effect, the structure delays the point at which the deal starts amortizing, or paying back principal to investors. This allows lenders to lock in the cost of funding for a longer period of time. In a prime auto deal, the shortest-dated tranche is less than a year and longest-dated tranche may be no more than three years.

“The obvious question is ‘How are bondholders protected from a deterioration, or migration, in the quality of collateral?’,” said Gerald Keefe, Americas head of securitized products at Citigroup, one of the deal’s lead underwriters. “The answer is all assets added to the pool have to meet the same eligibility criteria as the assets in the deal at closing,” he said.

For example, no more than 2% of cumulative additional receivables may have an original term-to-maturity above 75 months; no more than 10% can have original terms of between 73 to 75 months; and at least 22.5% must have an original term of less than or equal to 60 months. Also, no more than 40% of the cumulative additional receivables may be secured by used vehicles; and the weighted average FICO score of all cumulative additional receivables must remain at 630 or greater, according to the deal’s prospectus.

“When you go into amortization at the end of the first year, investors basically have the same risk they would have had if it had gone into amortization right away,” Keefe said.

The deal, Capital Auto Receivables Asset Trust 2013-1, was upsized from $940 million originally.

Santander’s deal also requires that added loans meet certain criteria, although the deal’s prospectus says the new loans can “vary somewhat” from those in the pool at the transaction’s close.

Receivables cannot be acquired through the pre-funding account if the effect of such an acquisition would reduce the weighted average contract rate of all subsequent receivables to less than 16.73%; cut the weighted average loss forecasting score to less than 561; increase the weighted average loan-to-value (LTV) ratio to more than 116.02%, cut the weighted average FICO score to less than 590; or increase the weighted average remaining term-to-maturity to greater than 69.55 months.

Keefe said there could be more auto loan securitizations with revolving periods, because the all-in costs “are still very compelling.”

“Yields on senior pay securities are now at historical lows; you can see why they might put a revolving period in to lock this in for longer,” he said