Moody’s Sees Silver Lining in Regulatory Scrutiny of Auto Finance

NEW YORK — An improving economy and job market should keep vehicles rolling off a dealer lots and finance sources active in the asset-backed securities (ABS) market, but the level of new ABS issuance will likely stay flat or rise modestly due to increased regulatory scrutiny and other market dynamics, Moody’s predicted in a report issued in mid-December.

Through November 2014, auto ABS issuance in the loan, lease and floorplan sectors topped $93 billion, up from $88.7 billion in 2013, according to the ratings agency. Ford Motor Credit was the largest issuer of prime auto loan ABS in 2014 with five transactions totaling $7.3 billion, while Santander was the largest issuer of subprime transactions with five deals totaling approximately $7 billion.

The ratings agency, however, predicts that credit quality of the loan pools backing new auto loan ABS securities transactions will deteriorate modestly in 2015, as finance sources loosen underwriting standards and take on a greater proportion of high-risk borrowers.

“Our expectation for cumulative net losses for 2015 transactions will be slightly higher than they were for pools backing transactions issued from 2010-2014, but still relatively low compared with losses from pools before the financial crisis,” said Corey Henry, Moody’s vice president and senior analyst.

But economic improvements will help maintain the strong performance of the collateral backing outstanding auto loan ABS in 2015, as will the presence of structural features in new and outstanding transactions that protect bondholders, the ratings agency noted. The firm said it also expects used-vehicles to rise slightly due to strong demand, which should boost recoveries in auto loan ABS and residual values in auto lease ABS.

Less stringent underwriting standards should also cause credit quality to deteriorate in subprime auto loan pools, the report noted. “… However, lenders have grown more cautious about relaxing underwriting too much,” it stated, adding that low interest rates and an improving economy are supporting loan performance and keeping losses at sustainable levels.

“Overall, performance of subprime loan pools will continue to be strong on a historical basis.”

The ratings agency did list the stretching of loan terms and a greater share of used cars in prime pools as signs of weaker credit quality. It noted that weighted-average original repayment terms have stretched from 61.9 months in 2010 for prime pools to 64.8 months. At the same time, FICO scores have decreased from 745 in 2010 to 737 in 2014 for prime pools.

And the ratings agency expects those longer-term prime loans to perform about two times worse than loans with traditional repayment terms of 60 months or less.

“Lenders, including Santander, Chrysler, Nissan and some banks, have started to securitize loans with 75-month repayment terms, longer than the 60 to 72 months in most loan contracts,” the report stated. “One lender, Bank of the West, issued an ABS deal in November 2014 that included loans with 84-month repayment terms. The deal was the first to include loans with this long of a term since before the financial crisis.”

The report also noted that OEMs such a Mercedes are starting to provide incentives such as interest rate reductions to keep certified pre-owned vehicles rolling off dealer lots — a trend Moody’s said should continue in 2015. This trend should also contribute to the deterioration of credit quality, with the ratings agency expecting cumulative net losses on used vehicles in prime pools to be 1.4 times higher than loans for new vehicles.

The expansion of leasing beyond luxury makes will also contribute to the decline in credit quality in new auto lease ABS, as manufacturers are expected to use the transaction type to increase loan affordability for customers as car prices continue rise. And as of October 2014, leasing as a percentage of new-vehicle sales jumped nearly 20%, up from about 22% in 2005.

“In 2014, GM Financial issued its first-ever lease securitization deals, which had lower weighted-average FICOs than previous lease transactions,” the report noted. “Specifically, the underlying pools in GM Financial’s 2014-1 and 2014-2 transactions had weighted-average FICOs of 727 and 721, respectively. By comparison, other lease deals issued since 2010 had a weighted-average FICO of 740 or greater.”

Moody’s said it also expects the performance of new and outstanding auto loan ABS deals to suffer temporarily due to continuing regulatory and legal scrutiny of debt-collection practices. It cited the $5.5 million settlement Consumer Portfolio Services (CPS) reached in May 2014 with the Federal Trade Commission, an agreement that required the company to change its collections practices.

“Although the new servicing requirements outlined under the settlement will bring the company in compliance with applicable laws and regulations, we expect the settlement will also result in less aggressive efforts by CPS to collect payments on delinquent loans,” the report noted.

The ratings agency said the regulatory scrutiny could also force thinly-capitalized sources out of the market. “Condor Capital Corp., for example, ceased operations after the New York Department of Financial Services sued the company in April 2014 under provisions of the Dodd-Frank Act,” the report noted. “The regulator accused the company of deceptive practices, including failing to pay customers refunds when they had positive credit balances and not safeguarding customers’ personal information.

“The credit quality of the loans backing auto loan ABS might improve over the long term, however, if the scrutiny results in curbs in unethical or imprudent originations, particularly in the verification of information that the borrower or dealer provides about the borrower’s financial wherewithal,” the report stated.

Moody’s also noted that the Securities and Exchange Commission’s adoption of Reg. AB II, which requires loan-by-loan disclosure, will improve third-party due diligence and “enhance the quality and veracity of the data provided by an auto ABS sponsor, lend transparency to the scope of exceptions made to underwriting guidelines, and result in more compliant practices with state consumer protection laws and the federal Truth in Lending Act.

The requirements, however, might cause issuers to flee the public markets temporarily as they improve their ability to report and disclose loan-level data, the report stated. But the ratings agency doesn’t believe these new regulations will cause the overall level of auto ABS issuance to decline. Instead, it believes 2015 issuance volume will depend largely on the extent to which lenders with other sources of funding choose to turn to the ABS market.

“Although we expect auto sales to continue to rise, which should lead to more issuance, lenders such as banks and captive financing companies might not access the ABS market as frequently,” the report stated, in part.

“Captive finance companies are likely to continue to be the more active issuers of auto loan ABS,” the report added. “New sponsors will also likely continue to bring deals to market in 2015. New subprime lenders also could tap the securitization market for funding … Also, credit unions could view the ABS markets as more favorable for funding as a result of a statutory proposal to isolate their assets.”

To read Moody's full report, click here.