ABS issuers face tough choices on surging costs

IFR 2460 - 19 Nov 2022 - 25 Nov 2022
5 min read
Richard Leong

US issuers of securitisations backed by subprime auto loans and unsecured consumer loans are struggling to raise money in the bond market as fund managers become more discerning and push for greater pricing concessions.

These two ABS categories have come under the greatest investor scrutiny due to their exposure to risky borrowers battling with higher inflation and tougher economic conditions.

As a result, funding costs have soared for these issuers within a matter of months. At the end of October, subprime auto lender Flagship Credit Acceptance priced a Double B rated tranche in a US$401m ABS some 900bp over Treasuries, far wider than the 345bp over Treasuries on a same-rated tranche in a deal it priced in February.

"People have been gun-shy about putting money to work," said John Kerschner, head of securitised products at asset manager Janus Henderson, adding Flagship's Double B spread was one of the widest ever for a subordinated ABS tranche.

And rather than caving to pressure to offer spread concessions, a small but growing list of ABS issuers have postponed their offerings and instead opted to lean on other channels such as bank warehouse lines and whole loan sales, bankers and investors said.

"Some of the deep subprime issuers are leery to issue at these wide levels," said Federated Hermes senior portfolio manager Nick Tripodes.

Supply slowing

Buy-now, pay-later lender Affirm and subprime auto finance firm Southern Auto Finance are among the issuers that suspended their offerings, people familiar with those issuers said. Capital One, LendingPoint, Global Lending, Tricolor Holding and Genesis Financial stopped marketing their issues even after submitting regulatory filings, according to buyside participants.

As a result, supply has slowed rapidly as the year has progressed, following record annual volume in 2021. Only US$28bn of asset-backed paper has come to market in the fourth quarter, which is less than half of the US$72.67bn sold in the third quarter and a fraction of the US$141.77bn from the same quarter in 2021, according to Refinitiv data.

If an issuer decides to bring a securitisation, it has to be prepared not only to pay a far wider spread compared with past trades but may also need to retain the lower part of the capital structure, which further raises their overall costs.

"It's not the easiest environment [in which] to launch bonds," said David Petrosinelli, a senior trader at broker-dealer InspereX. "It tells you about the reticence in the market. It’s a reflection that credit quality is weakening."

Defaults and delinquencies on subprime auto loans and unsecured consumer loans have seen an alarming reversal from historic lows, triggered by the start of the Federal Reserve's aggressive rate-hike campaign in March.

The average annualised net losses on subprime auto loans rose to 7.17% in October, up 308bp from a year ago, while those on marketplace personal loans increased to 12.57%, up 762bp from last year, according to research by Barclays.

Still, some issuers have no choice but to come to market despite having to pay significant spreads, in part because banks are seeking to reduce their exposure to riskier loans and so have urged clients to reduce usage of warehouse and revolving credit lines. Other issuers have decided to bring deals now rather than risk potentially even higher levels as the Fed rate hike cycle continues, market participants said.

Persistent market volatility has also contributed to the troubles facing banks trying to place paper with investors skittish about dwindling liquidity and a potential pickup in fund redemptions.

Good news

There was better news elsewhere in the structured finance market, however, with top-tier issuers in liquid sectors like prime auto and credit cards still finding it relatively easy to access the market. Indeed, credit market conditions actually improved last week in the wake of a smaller-than-expected 0.4% increase in US consumer prices in October, which raised hopes the Fed would slow its pace of rate increases, and resulted in a huge drop in Treasury yields. As a result, the ABS primary market posted one of its busiest weeks this quarter with nearly US$4.9bn in paper printed in three days.

"It helped to bring people back into the market," a senior ABS banker said of the latest CPI report.

ABS issuers face tough choices on surging costs