25 Feb 2008, Rob Davies, Risk magazine
The rating agency’s 60-day+ delinquency index for prime auto ABS deals was 0.77% in January, 44% higher than in the corresponding period in 2007. Subprime auto loan delinquencies stood at 4.03%, the first time they have exceeded 4% since 1997.
Fitch’s annualised net loss index for prime auto loans is 1.28%, while the equivalent subprime index is 8.48%, a 12% increase from December.
Rising mortgage payments, high fuel prices and unemployment touching 5% make it unlikely that the immediate future for the asset class – which saw $67 billion of issuance in 2007, according to Thomson Financial - will improve soon.
“Given that there is not too much good news surrounding the economy at present, it seems likely we will see performance deteriorate further in the short term,” says Hylton Heard, New York-based director of auto loan ABS ratings at Fitch. “We are approaching the period of tax rebates and refunds, which might help short-term performance, but beyond that, there isn’t much to suggest the outlook will improve.”
However, analysts say performance would have to deteriorate significantly beyond current levels before transactions faced similar ratings pressures to those that blighted subprime mortgage securities.
“Current delinquency levels suggest a return to normalisation of performance,” asserts Pia McCusker, Boston-based head of cash ABS research at State Street. “At this stage it is not serious, but as the year goes on and there is a clearer picture on the state of the economy, it might be something people have to focus on more.”
McCusker believes mortgage contagion will first reveal itself in the subprime auto loan sector. “In the mortgage sector, you find overleveraged borrowers. Unemployment is supposed to rise and underwriting across the board is getting tighter,” she explains. “People wanting to refinance will find it increasingly difficult, which could have a knock-on effect. Hopefully this won’t be significant for prime and near-prime deals, but it could affect some subprime transactions.”
As was the case with subprime mortgages, auto loans originated in 2006 have underperformed earlier vintages. According to research from Lehman Brothers, 4.5% of prime loans are delinquent by 30 days+, rising to 12% for subprime loans.
However, investors can take comfort in fundamental differences between the assets. Auto loans feature full documentation, which was not the case with all subprime transactions. Additionally, some subprime mortgage-backed deals featured new loan types. The lack of history associated with these made accurate stress testing difficult, a fact that came back to haunt originators, arrangers and rating agencies.
Conversely, auto loan ABSs are regarded as a tried and tested asset class. “It has gone through a number of credit cycles so you would assume the rating agencies have made sure structures are tested to withstand significant deterioration,” says McCusker.
This track record is a significant reason issuance has not shut down. In fact, the $5.85 billion issued in January was higher than the corresponding month in 2007, with the likes of Ford Credit, General Motors and Nissan deciding to brave testing market conditions.
“Although January was a good month, credit market issues generally determine the number of new transactions and it has become more expensive for issuers of late,” notes Heard.
Chrysler priced a $1.5 billion transaction in January, with spreads of 85 basis points over Libor for the money market tranches and 105bp over swaps for two-year AAA notes. The equivalent tranches in a November offering by the same company priced at 58bp and 78bp.
Apart from wider spreads, originators need to structure in additional credit cushion to entice investors. Subordination for the senior notes in Chrysler’s recent offering stood at 7.75%, compared with 6.5% in 2006 and 3% in 2006. This was for a prime offering. Subprime originators, active users of monoline guarantees for credit enhancement, will probably have to structure in further subordination if the monoline option is closed off.
While rising delinquencies are concerning, McCusker believes there are opportunities for savvy investors. “Prime AAA auto ABS notes are pricing in the 90bp range: before the crisis they would have been flat or plus five. A lot of investors are focusing on the secondary market. You have a seasoned asset performing well, so investors can afford to be picky,” she concludes.