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Wednesday, 19 December 2018

Sub-prime auto puts more junk in trunk

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Car finance companies have pushed into fresh territory this year by selling Single B rated debt backed by loans made to sub-prime borrowers.

Selling Double B bonds was a bold trade not so long ago but as demand has grown for riskier assets, auto sellers are now able to sell further down the capital structure.

“It would appear that investors have grown comfortable with this collateral,” S&P auto ABS analyst Amy Martin told IFR.

“But some investors who are buying this class stand to lose principal if losses are just mildly higher than expected.”

American Credit Acceptance, First Investors, Foursight Capital, United Auto Credit and Westlake have each sold Single B bonds this year, according to Intex data.

By migrating to Single B from Double B, investors can pick up a bit of the spread that has vanished from less risky classes.

Last summer Double B spreads sank to a post-crisis low of around 300bp. But by last month, Westlake had cleared its Double B notes at 205bp, according to IFR data.

Its Single Bs fetched 325bp to yield 6.1%.

“It will be one area to watch,” a senior ABS banker told IFR this week.

“We used to say that the Double B window was not always open. Now multiple companies are selling Single Bs.”

Speculative grade bonds often widen when markets lurch into choppy territory.

Roughly a week after Italian political turmoil shook parts broad swathes of the market, ABS investors turned to safe-haven Triple As from Hyundai and DriveTime.

That was a departure from much of this year when investors plowed orders first into anything lower rated and higher risk.

In addition to volatility, a specific challenge for sub-prime auto investors has been rising loan losses.

Net losses climbed in each of the past six years, reaching 7.62% in March according to S&P’s sub-prime auto ABS index.

And while only two defaults so far have occurred in sub-prime auto bonds rated by S&P - both Double B tranches - that could change as higher-risk bonds are sold.

Rating agencies warned that the Double B class of Honor Finance’s one and only sub-prime auto securitization could be downgraded. nL5N1SW5A4

“We do expect that the next economic/auto downturn will shake out the weakest ABS issuers from the current long list,” JP Morgan analysts wrote last week.

“However, auto ABS bonds are still very well structured to withstand stress, including possible seller/servicer events.”

 

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