As auto lenders begin relying more heavily on favorable execution in the whole loan markets, investors are seeing more of an aggressive structure hit the sector. While the concurrent pay structure has obvious benefits to the issuer, it also heightens the extension risk for subordinate buyers, if the transaction is structured too aggressively.
While the $1.2 billion GS Auto Loan Trust 2004-1 from Goldman Sachs is the sixth offering with this structure (the five previous dealer auto loan deals are concurrent payers), the proliferation of the whole loan market for lenders has many predicting auto principal finance as the next trend in the sector.
The concurrent pay structure, described as a variation of the pro rata structure, allows overcollateralization and excess spread to be interchangeable as targeted credit enhancement. Issuers - banks in this case - benefit from a lower cost of funding because they forgo a fully funded reserve account at the time of pricing.
There are mixed reviews so far, however, for the concurrent pay structure since the first such transaction hit from SSB Auto loan Trust in November 2002. Issuers get favorable execution in the increasingly hot whole loan markets, and investors get automatic diversification by buying a single offering, backed by up to three originators.
"This is great for an issuer," one banker away from the deal said. "High coupon subordinates are structured to a shorter duration and there is no up-front cost of a reserve account, which is funded through higher-cost unsecured borrowing."
However, bankers and sales forces are less forthcoming about the risk to investors if target levels, set to divert excess spread from subordinate bonds to seniors, are unrealistically tight and subsequently tripped.
"This will be targeted to two types of investors," said one buysider who is passing on GSALT 2004-1. "One type is unsophisticated and the other is gambling that the subs pay down before any triggers are tripped," he added. "Also, in order to protect the senior enhancement, the servicing fee is subordinated...Haven't we learned anything?"
While the excess spread enhancing 1.02% servicing fee is subordinated, in the event that Goldman Sachs Mortgage Co. is removed as servicer, the fee would move to the top of the waterfall, according to the GSALT 2004-1 presale report from Moody's Investors Service. Moody's adds that it "views the risks of default [of Aa3 rated parent company Goldman Sachs] during the expected term of the transaction to be very low."
Should a deal trip three-month average net loss triggers, the structure converts to a sequential payer, putting subordinate holders at the bottom of the waterfall. In this case, principal payments are diverted from sub bonds to support the seniors, until triggers are cured, potentially extending bonds an additional two years.
"The reason sequential payers have been structured into home equities is that 75% to 80% of pro-rata bonds trip their triggers," the investor added. When a trigger is hit on a five-year double- or single-A [home equity] bond, it becomes an 11-year bond." Extension risk, however, is not a credit issue and is not addressed in the presale report.
In the GSALT 2004-1 triggers step up over the next three years. Breaches occur should three-month net losses top 1.5% through January 2005, 2.25% through January 2006 and 2.50% from February 2006 until final maturity. Senior notes must be supported throughout the life of the transaction by at least 12% credit
"Investors don't necessarily care if enhancement is O/C or subordination," the banker added. "In general, investors prefer bonds to pay sequentially, but as long as the deal performs in the expected case, there won't be an issue."
GSALT 2004-1 is structured to consist of a 2a7 money market tranche as well as one-, two-, and three-year seniors, offered to investors as both fixed- and floating-rate bonds. Roughly $112 million in fixed-rate subordinate bonds, from single-A down to double-B, will have one-year average lives.
Additionally, GSALT 2004-1, like all previous auto principal finance transactions, is backed by prime collateral. More than 71% of the loans are originated by Hunting National Bank, with the remaining 28.4% originated by Ford Motor Credit.
Moody's cites Huntington's declining loan-to-value trends, as well as its increasing average FICO scores, as being strengths of the deal, while the relatively short seasoning and longer-dated loans potentially offset these strengths.