DBRS Assigns Provisional Ratings to BMW Canada Auto Trust 2018-1 Notes

DBRS Limited (DBRS) assigned the following provisional ratings to the Class A-1, Class A-2 and Class A-3 Notes, Series 2018-1 (collectively, the Notes) issued by BMW Canada Auto Trust:

-- Class A-1 Notes, Series 2018-1 (the Class A-1 Notes) provisionally rated AAA (sf)
-- Class A-2 Notes, Series 2018-1 (the Class A-2 Notes) provisionally rated AAA (sf)
-- Class A-3 Notes, Series 2018-1 (the Class A-3 Notes) provisionally rated AAA (sf)

The Notes will be supported by a portfolio of retail closed-end lease contracts of new passenger cars and sport-activity vehicles (the Portfolio of Assets). The lease contracts were originated by authorized BMW dealers in Canada.

Repayment of the Notes will be made from collections from the Portfolio of Assets, which includes scheduled monthly lease payments (including residual value payments in the case of customer-retained vehicles) as well as proceeds from vehicle sales either at the end of the lease term or earlier, in the case of prepayments and defaults. Proceeds from excess mileage and wear and tear charges, if any, also form part of the collections used to repay the Notes.

The pass-through structure repays the Notes as monthly principal payments are collected from the Portfolio of Assets. The Notes will be repaid in sequential order, with the Class A-1 Notes being repaid first, followed by the repayment of the Class A-2 Notes and finally the repayment of the Class A-3 Notes. The ratings assigned are based on the full repayment of the Notes by their respective Maturity Dates.

The provisional ratings incorporate the following considerations:

High Level of Credit Enhancement
Target overcollateralization (OC) of 17.75% plus 0.25% of cash plus excess spread. On the Expected Closing Date, 15.50% of credit enhancement will be available (0.25% of cash and 15.25% of OC). Excess collections will be applied monthly to repay outstanding principal of the Notes until the OC reaches the target (17.75% of the initial securitization value), which is expected by month six based on scheduled payments. In addition, 3.95% (annualized) of estimated excess spread, net of the indicative cost of funds and the Replacement Servicer Fee provision, will be available to offset any collection shortfalls on a monthly basis.

Non-Amortizing Credit Enhancement
The requirement to maintain the cash account and the OC amounts at their target levels provides a deleveraging structure as principal on the Notes is repaid. Residual values represent the largest risk in closed-end auto lease securitizations, and the exposure to such risk is highest at contract maturity. Non-amortizing credit enhancement ensures that an increasing level of protection is available to offset potential vehicle disposition losses as these contracts mature.

Conservative Advance Rate on Residual Values
The Base Residual Value is determined by using the lower of the contract residual values or the Automotive Lease Guide (ALG) estimated values as of May–June 2018. The reference to the ALG values in setting the advance rate on the Notes ensures that expected embedded losses (negative equity in relation to residual values) will not be funded on the Expected Closing Date, effectively reducing residual value risk in the Portfolio of Assets. ALG projects its residual values primarily based on auction proceeds and forecasts of economic factors, such as the increase in used vehicle supply starting in 2017. Overall, the ALG values represent an independent estimate of the expected wholesale value of the vehicles in the portfolio at maturity.

Strong Obligor Profile
The obligors of the underlying lease contracts represent high-credit-quality customers, as the weighted-average FICO score is 804.6. Over 57% of the pool has a FICO score of greater than 800. The strong credit profile is also supported by low credit losses and delinquency levels of the Seller’s owned and managed portfolio in the last five years.

Established Remarketing Strategy
BMW Canada has an established vehicle remarketing strategy to maximize the disposition proceeds and minimize the time to remarket the vehicles should they be returned at or prior to maturity. Historical trends demonstrate BMW Canada’s ability to leverage its dealer network and other dealer groups across Canada to purchase off-lease vehicles. Certified pre-owned and pull-ahead programs offered by BMW Canada improve the management and value of off-lease inventory, and the strategy of selling directly to the dealers reduces the reliance on remarketing vehicles through physical auctions, which generally yield lower proceeds. In 2016, BMW Canada implemented a business strategy that focuses on dealership preference to purchase vehicles through the online auction channel, resulting in an increase in online auction sales and a decrease in physical auction sales compared with previous years. The enhancement levels are robust enough, however, to support a turn-in rate above 95% and disposition through third-party auctions, assuming the more attractive channels are unavailable.

Operational and Brand Strength of Seller
The Seller and its parent, BMW AG (the Company), were upgraded to A (high) with a Stable trend by DBRS on July 14, 2017. The corporate rating upgrade recognizes the Company’s conservative financial policy and solid revenue and earnings performance, as well as its manageable exposure to adverse effects resulting from ongoing diesel vehicle restrictions in Europe. BMW AG continues to maintain its strong business profile as the world’s leading automotive manufacturer in the premium vehicle segment. BMW has had a strong start to 2018 in Canada, with a 4.5% increase in vehicle sales in Q1 2018 (compared with the same period in 2017). As a subsidiary of BMW AG, BMW Canada benefits from its parent’s strong financial standing, global presence and brand values, allowing it to leverage the experience and expertise of BMW’s other financial services companies worldwide to ensure sound and consistent underwriting standards and efficient servicing operations.

Strong Demand in Luxury Vehicle Segment
The growing popularity of luxury vehicles in Canada continues to support their residual values. Luxury vehicle manufacturers had another strong year in 2017, with almost all of them achieving record sales in Canada. Sales of luxury vehicles in Canada increased to 11.6% of sales in 2017, up from 6.1% in 2000 as a result of several factors:
-- Canada has one of the largest shares of the baby boomer population, who have created significant wealth over their lifetimes.
-- Customers who had previously taken advantage of the Canadian dollar being at par with the U.S. dollar to purchase imported luxury vehicles are now more likely to remain in the luxury market rather than revert back to a mainstream vehicle.
-- There is a greater variety of product and high-quality vehicles being offered by luxury manufacturers, providing customers with the latest technology at various price points. Most notably, the expansion of the luxury compact segment has successfully transitioned mainstream buyers into luxury buyers.
-- The development of certified pre-owned programs has helped expand the luxury used-vehicle market and bolsters residual values.

Notes:
The principal methodologies are Rating Canadian Auto Retail Loan and Lease Securitizations (October 2017) and Legal Criteria for Canadian Structured Finance (July 2017), which can be found on dbrs.com under Methodologies.

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link under Related Documents or by contacting us at info@dbrs.com.

The rated entity or its related entities did participate in the rating process for this rating action. DBRS had access to relevant internal documents of the rated entity or its related entities in connection with this rating action.

The full report providing additional analytical detail is available by clicking on the link under Related Documents below or by contacting us at info@dbrs.com.

For more information on this credit or on this industry, visit www.dbrs.com or contact us at info@dbrs.com.