Securitisation 2005 - More cars, more tiering
The US ABS sector should be able to absorb additional auto issuance from General Motors and Ford as these companies find themselves forced to finance business via the securitisation markets. But as this issuance is expected to climb, spreads are likely to widen further and tiering will continue between foreign automakers and American bonds well into the year. By John D’Antona.
The ABS market largely shrugged off S&P's recent downgrades of GM and Ford to BB/B-1 and BB+/B-1, respectively, from BBB–. But given the newly acquired junk status, the automakers' increased reliance on the securitisation market for funding has already been anticipated and factored into the market, analysts say.
According to Brian Zola, auto ABS analyst for Lehman Brothers, "We estimate Ford Motor Credit and GMAC could require US$20bn to US$25bn each of auto ABS issuance through 2005. The term ABS market may bear the brunt of the new deal supply as the automakers are likely to want to maintain spare capacity in their ABCP programmes. The figures were calculated assuming current retail auto sales, an inability to access the unsecured market, small increases in ABCP funding, and small increases in whole loan sales."
Gyan Sinha, ABS analyst at Bear Stearns, comes up with similar figures for GMAC and Ford issuance for the year, estimating that both companies need approximately US$30bn in funding for 2005.
"There is a fair amount of capacity in ABS market to accommodate their funding needs," said Sinha. "The ABS market is much bigger and broader today which bodes well. Auto structures are incredibly clean and frequently upgraded."
If all of this new issuance comes under their regular auto loan shelves, Sinha estimates this would constitute 60%-67% of the auto ABS market.
While auto paper is generally fixed-rate in nature, it tends to be of shorter duration and rolls off quickly, making it more palatable to investors in a rising rate environment, explained Sinha. Also, the prime nature of the underlying borrower will make investors "ready to step up" and absorb this incremental risk as headline risk is separate and de-coupled from asset credit quality.
Investors have demonstrated more patience in buying auto ABS and adjusted their bids accordingly. Knowing issuance is poised to grow significantly, if they fail to purchase bonds now, chances are they can get them at a later time – possibly at a better price.
A structuring head at a New York bank explained how investors now have something they have not had in quite a while when it comes to new deal issuance and tight spreads.
Unlike at the beginning of the year, when each successive auto deal was oversubscribed – keeping spreads hyper-tight – demand is now less aggressive.
"ABS investors now have leverage in the auto sector – they can be a bit more hesitant in what they buy and at what levels," he explained. "Investors are in a more wait-and-see mentality instead of the herd mentality, stampeding to buy deals for fear of being shut out."
Lehman's Zola suggests, based on expectations of increased issuance of US$20bn to US$25bn for both automakers or an average of one US$3bn deal per month, this could lead to as much as a 25bp widening for Triple A rated three-year spreads from current levels of swaps plus 6bp.
"A combined US$40bn–$50bn in issuance brings on the risk of investor satiation in the FORDO and CARAT names," he said. "One positive note is the short-duration, fast amortisation of retail auto ABS. Approximately US$6bn of the current Ford/GM outstandings is expected to amortise by year-end."
One investor from the Northeast put it plainly: "With the expectation that more auto deals will come – at least from GM, Ford and possibly others – why bid up when you can sit back and wait for wider levels?"
In Ford's latest auto deal, this bears out. FORDO 2005-B, which completed in mid April amid the company revising its earnings, the Triple A rated three-year class priced at interpolated swaps plus 9bp versus plus 1bp for an identical class in its first deal of the year which completed in early January.
As a direct result of the weakening position and wider pricing of GM and Ford issues, tiering has developed in the US auto ABS market, with top non-US issuers – Honda being the most recent example – pricing considerably tighter than Ford and GM. The latter pair are now trading closer to less well-known issuers such as WFS and Carmax.
Honda and Ford traded on top of one another at the beginning of the year, with Honda perhaps 1bp tighter in tranches longer than two-years. But now, after the one-two combination of poor earnings and sales forecasts by the US duo, spreads have widened to 4bp.
The senior one-year tranche of the most recent Honda deal priced at EDSF plus 2bp, marking the tight end of the range of auto ABS spreads. In contrast, GMAC priced its latest US$1.5bn CARAT auto lease securitisation with a Triple A rated one-year class coming in at EDSF plus 12bp. The US$3bn FMCC securitisation that priced prior to the GMAC one included a one-year piece at EDSF plus 6bp.
Peter DiMartino, head of ABS Research at RBS Greenwich, said expectations of increased supply were driving the differentiation. "My opinion is that the market expects Ford and GM will have difficulty issuing unsecured debt, hence they expect a lot of ABS to hit the market," he said. "That interrupts the current balance between supply and demand at spread levels prior to the widening."
There is tiering within the captive auto ABS sector as the domestic automakers are faced with future supply concerns and corporate news, said Jeff Salmon, head of ABS research at Barclays. "The view is that foreign automakers are without these earnings or healthcare issues, which has led to their better pricing."
Both Ford and GM cite soaring healthcare costs as a chief problem.
Further tiering is likely to be limited as auto ABS continues to perform well across the board. "If you look purely at the credit quality of Honda and GMAC's portfolios, their loss rates are nearly identical," Salmon said. "This is all spillover from the corporate sector."
FMCC and GMAC are now trading in line with the likes of WFS and Carmax. WFS's most recent transaction, completed in late March, included a Triple A rated one-year class at EDSF plus 2bp, while a Carmax deal in late March featured a senior one-year tranche at EDSF plus 4bp.
But analysts noted that even Honda's most recent offering, HAROT 2005-1, did price 2bp to 4bp wider than its securitisation in early January because of the general back-up in credit spreads.
"Honda performed strong right out of the gate," affirmed a source familiar with the securitisation. "The deal is backed by solid collateral of new and certified used vehicles, which over time have proved to hold their values well, making the offering very attractive. Honda also has a solid cash position and earnings, which makes it a different story than Ford or GM."
Despite penalising GM and Ford for their poor sales figures and earnings, investors are just as willing to reward other auto issuers, such as DaimlerChrysler which returned to the market with its second auto lease backed securitisation amid much investor fanfare. The US$2bn deal priced tighter than expectations as investors applauded the company for being the only Big Three carmaker able to maintain sales that are not entirely linked to sports utility vehicles (SUVs).
"DaimlerChrysler did extremely well and easily came inside of price talk," recalled Barclays' Salmon. "With them, you have a company that has cashflow and a non
SUV-dependant line-up. Just look at their product line – there are no cookie-cutter cars that are basically the same thing but re-badged for a different division."
Investors agreed, as most classes of the deal were oversubscribed and priced tightly, leading to its enlargement to US$2bn from US$1.5bn. The US$680m Triple A rated 2.1-year class priced at swaps plus 4bp and the one-year class was completed at EDSF plus 4bp, both 1bp better than guidance.
While the overall pricing levels were wider than in January when spreads were at their tightest – reflecting the overall market and sector widening based on headline news events – Daimler's spreads are better than those achieved by recent GM and Ford offerings. A US$315m Triple A two-year class from GM's CARAT transaction completed in late April priced at one month Libor plus 10bp. The Triple A rated one-year class was completed at EDSF plus 12bp.
"We decided to play in the Daimler deal," said Allan Berliant, portfolio manager at GMO Investments.
While not a regular buyer of auto ABS, he felt the money market classes were just "too attractive" not to purchase, given the company's solid fundamentals. "Daimler managed to stay out of the trouble the other Big Three makers find themselves in. So we decided to take some exposure to them as this is a quality deal."