DBRS Morningstar’s Takeaways from ABS East 2021: Rising Used Vehicle Values Fuel Strong Auto ABS Performance

As part of its takeaways series, DBRS Morningstar is publishing several write-ups about pertinent topics discussed at ABS East 2021, an industry conference for the asset-backed securities sector. On the first day of the conference, DBRS Morningstar’s Ines Beato, Senior Vice President, took part in a panel discussing auto ABS. While auto ABS performance has begun to somewhat normalize after the peaks and valleys of the pandemic, it has upended conventional wisdom about car values: used vehicles don’t necessarily depreciate after leaving the lot and going home with a buyer.

The biggest performance impact on auto ABS deals followed shortly after the onset of the pandemic. Beato said extensions for both prime and subprime loans peaked in April and May 2020, but they settled down to pre-pandemic levels by June and July 2020. Normally at 2% to 4%, the extension rate for subprime loans has always been higher than prime because those borrowers are more likely to live paycheck to paycheck; these extensions reached a high close to 16% early in the pandemic. However, prime loans saw the biggest percentage increase in extensions, given that those loans started at a very low base rate. This spike has not translated into losses because servicers have been prudent in granting extensions. “Servicers have been using extensions as a loss mitigation tool for many years,” she said. Close to 99% of the obligors that receive extensions return to making regular payments. Lenders offered prime borrowers three-month extensions, but they were more hands-on with subprime borrowers, offering one-month extensions and keeping in touch to see if another one was necessary. This contact allowed lenders to offer extensions on an as-needed basis.

In recent months, extensions and delinquencies have ticked up, but that’s mainly the result of regular seasonality, according to Beato. She expects this seasonal uptick to continue into 2022. Thanks to government stimulus measures and fewer opportunities to spend disposable income, obligors are starting off better from a credit perspective than in prior years. Beato projects this to help auto ABS performance over the coming months, but she does expect some deterioration. However, ratings are likely to remain stable. Even if losses were to increase, auto ABS deals typically have robust sequential-pay structures that lend stability to the ratings. Historically, even when expected losses increase, there have been upgrades in certain transactions given the growth in credit enhancement.

According to Alin Florea, Vice President at Barclays, his company assumes that new auto ABS securitizations will begin to pull back in Q2 2022. Barclays forecasts auto ABS issuance to taper to $125 billion to $130 billion in 2022, down from the record of more than $135 billion in 2021. New vehicle sales peaked this past summer and have come down quite a bit; they now mirror recession-level numbers, though in this case it is not because of a recession. “Sponsors won’t need to issue as much paper as they have in 2021,” Florea said.

Like the housing market, the current used car market is reflecting the lopsided balance between supply and demand. “At the baseline, it’s fundamental economics,” said Praveen Joseph, Head of U.S. Securitized Credit Investments at International Finance Corporation. The global semiconductor chip shortage and congested shipping ports have constrained car manufacturing, making used cars more valuable. Florea noted that Manheim, an auto auction company, said used car prices were 43% higher in November 2021 than they were a year ago. To put it into dollar terms, the average price for a used car was just above $12,000 in November 2019, according to Manheim, and more than $21,000 in November 2021.

Florea noted that high used-vehicle values have affected two auto ABS metrics in particular. First, loss severities are much lower than historical norms. Loss severities for prime auto ABS deals have fallen as low as 20% this past spring compared with the average of 45% a decade ago. Subprime auto ABS loss severities reached a low of 30% in spring 2021 compared with historical loss severities hovering around 55%. Second, prepayment speeds are faster, with borrowers paying off their loans sooner, and prepayment speeds are up about 10 basis points to 20 basis points across both prime and subprime loans. “We’ve heard anecdotal evidence to corroborate these numbers. We’ve heard of dealers calling customers that have recently purchased a vehicle and asking them if they are willing to sell it back to [the dealer] at a profit,” he explained. According to Beato, the number of vehicle trade-ins is slightly lower in lease deals. Most of these obligors are cashing out as well instead of trading in. However, when trade-ins do happen, there are record gains on sales for both the obligor and the dealer. With people buying used vehicles for larger sums, what will happen to auto ABS securitizations if values suddenly drop in the future? Beato noted that lenders seem to be prudent regarding greater loan-to-value ratios, lending to borrowers with higher FICO scores, or requiring larger down payments as a way to mitigate this risk.

Environmental, Social, and Governance (ESG) factors made an appearance in the panel discussion, as they have become prominent topics in the investing community. Ultimately, there are some concerns about the limited data and how to measure ESG risk. According to Beato, DBRS Morningstar has not changed its criteria or rating process for auto ABS, in part because there hasn’t been a huge percentage of electric vehicles in the pools that it rates. There are few data on how electric vehicle values perform over time versus the wealth of data for gas-powered cars, even down to the model. Florea could think of only one auto ABS deal that has definitely met the ESG designation, which was a securitization from Toyota in 2018 backed by hybrid vehicles, and there hasn’t been one since. He wondered if auto ABS issuers might follow OneMain Financial’s lead and aim for the social part of ESG. The personal loan lender incentivizes borrowers to use its financial education platform to receive a break on their interest rate. Still, there is the question of how to score these ESG assets, which Joseph says his company is trying to figure out. For example, making batteries for electric vehicles is more emissions-intensive, and the electricity to charge the vehicles does draw from power grids that still use some level of nonrenewable resources.

Compared with the corporate bond world, securitized assets still have a way to go before fully integrating ESG.

Written by Caitlin Veno

Notes:
For more information on auto ABS, visit www.dbrsmorningstar.com or contact us at info@dbrsmorningstar.com.

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