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Structured Finance

Structured Finance






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    Structured Finance Structured Finance Document Transcript

    • Structured Finance Asset-Backed A Map to Rating Auto Loan- Special Report Backed Securitizations Analysts s Summary Chris Mrazek Since the inception of the asset-backed securities (ABS) market, auto 212 908-0667 loan securitization has been a vital part of total ABS volume. While cmrazek@fitchibca.com auto ABS has constituted a smaller portion of the total market in recent years, these securities still contribute significantly to overall issuance Joseph Astorina 212 908-0714 and are expected to remain a key component of the market in the years jastorina@fitchibca.com to come. Strong vehicle sales, attractive funding rates, and investor demand for short-term, highly rated liquid securities, characterized by James R. Grady steady performance, prudent portfolio growth and investment-grade 212 908-0664 servicers, will continue to drive issuance. jgrady@fitchibca.com This report outlines Fitch IBCA’s approach to evaluating securitizations Coley M. Lynch backed by retail auto loans, concentrating on prime quality loans. It 212 908-0726 clynch@fitchibca.com covers all aspects of Fitch IBCA’s rating criteria, including collateral evaluation, credit analysis, structural considerations, and legal issues, as well as discussions concerning originations, underwriting, and servicing. Fitch IBCA-Rated Prime Issuers s Market Outlook • Banc One Auto Grantor Trust Auto-backed issuance in 1999 is expected to exceed last year’s volume • Capital Auto Receivables Asset Trust due to strong new vehicle sales in 1998 and the first-quarter of 1999, • Chase Manhattan Auto Grantor Trust as well as improving ABS market conditions. Fueled by a healthy • Chase Manhattan Auto Owner Trust economy and low interest rates, sales of new vehicles and light trucks • Chevy Chase Auto Receivables Trust topped 15.5 million units in 1998 and posted double digit growth in the • First Bank Auto Receivables Trust first quarter of 1999. In step with robust sales, first quarter 1999 auto • Ford Credit Auto Owner Trust ABS issuance outpaced 1998’s first-quarter by over 25%. Current • GMAC Grantor Trust projections estimate 15%–20% growth over last year’s volume. Prime • Honda Auto Receivables Trust retail loans, which supported more than 75% of total auto issuance in • Key Auto Finance Trust 1998, are expected to back the majority of 1999 deals. The expansion • Norwest Auto Trust of the auto finance market will continue to propel securitization • Premier Auto Trust volume, although the widespread consumer acceptance of leasing and “balloon loans” may encroach upon the supply of retail loans for securitization. Retail auto sales remain dominated by the Big Three — Ford Motor Co., General Motors Corp., and Chrysler Corp. (now DaimlerChrylser), which consistently garner more than 70% of market share. While the retail auto securitization market had appeared to become less reliant on issuance from the Big Three than in the past, the U.S. captives’ share of auto issuance rebounded in 1998 and is on a similar course in 1999. However, many banks, independent finance companies, and foreign manufacturers’ captive finance subsidiaries, particularly the Japanese, continue to access the ABS market, seeking the benefits of securitization, including diversification and lower cost of funds. June 11, 1999 www.fitchibca.com
    • Structured Finance Auto ABS vs. Total ABS Issuance Prime Auto ABS vs. Total Auto Issuance (Public) (Public) Auto ABS Other ABS Prime Auto Other Auto ($ Mil.) ($ Mil.) 250,000 40,000 35,000 200,000 30,000 150,000 25,000 20,000 100,000 15,000 10,000 50,000 5,000 0 0 1994 1995 1996 1997 1998 1Q99 1994 1995 1996 1997 1998 1Q99 Source: Asset Backed Alert. Source: Asset Backed Alert. s 1998 In Review Consolidation affected the industry as well as Public Auto ABS experienced modest growth in issuance in 1998. In addition to the wave of bank 1998, falling short of expectations due to several mergers and acquisitions, 1998 saw consolidation at factors, including widening spreads, industry the manufacturer level. Chrysler Corp. merged with consolidation, the partial collapse of the subprime Daimler-Benz to form DaimlerChrysler, Ford Motor market, and issuers turning to alternative funding Co. acquired Volvo AB’s passenger car operations, sources. Poor market conditions late last year and Nissan Motor Corp. was solicited by a few curtailed overall ABS issuance in the fourth quarter, potential buyers, with Renault S.A. eventually taking and many auto lenders relied on asset-backed a large equity position in the company. commercial paper conduits and warehouse lines to fund growth. Certain highly rated entities elected to Securitizations backed by auto loans to individuals finance loans on balance sheet during the disruption. with imperfect or incomplete credit histories Additionally, General Motors Acceptance Corp. (subprime), which surged in 1996 and 1997, nearly (GMAC) was absent much of the year due to now ceased in 1998, except for those wrapped by bond resolved labor strike and production issues. insurers. Several upstarts succumbed to the consequences of aggressive accounting and underwriting activities, undercapitalization, weak servicing, and ineffective disposition efforts. Many Big Three Auto ABS vs. Total Auto well publicized bankruptcies caused speculation Issuance about the industry as a whole and severely trimmed (Public) issuance. As a result, the majority of public subprime auto transactions in 1998 were insured. This Non-Big Three Big Three phenomenon will likely continue, as many specialty ($ Mil.) finance companies lack the requisite capitalization, 40,000 loss history, loss stability, and investor appetite to 35,000 complete an economically efficient securitization on 30,000 an uninsured basis. 25,000 20,000 s Performance Trends 15,000 Competition, increased used vehicle financing, longer 10,000 financing terms, softer used car market, and rising 5,000 consumer bankruptcies led to lower recovery values 0 and contributed to higher losses on auto pools in 1995 1994 1995 1996 1997 1998 1Q99 and 1996. Issuers reacted, revisiting underwriting guidelines and servicing efficiencies in an effort to Source: Asset Backed Alert. stabilize performance and ensure the credit strength of future originations. The results of these measures A Map to Rating Auto Loan-Backed Securitizations 2
    • Structured Finance The graph below represents weighted average U.S. Vehicle Sales composite static loss curves for auto deals issued 1998 vs. 1997 Market Share and rated by Fitch IBCA in 1995–1998. As indicated earlier, losses were most severe in 1995 Big Three Other and 1996 as a result of increased competition and (%) looser underwriting practices. As issuers reacted, 100 lower losses were seen in 1997 and improved 80 further in 1998. 60 s Collateral Analysis 40 Loan Characteristics 20 The vast majority of loans in auto securitizations originate with an application sent to the finance 0 company by a dealer, although some securitizations 1997 1998 Jan-98 Jan-99 contain loans directly originated by the issuer. Direct originations occur mostly in securitizations by bank Source: Ward's Auto Info Bank. issuers, in which customers fill out a loan application at a local branch. Fitch IBCA considers many variables when analyzing the collateral behind an auto loan are now being realized, as losses on newer securitization, including vehicle age, downpayment, originations are showing signs of improvement. advance rate, depreciation, term, pricing, and geographic diversification. In addition, Fitch IBCA Other trends that should contribute to better examines credit scores and tier classifications to gauge performance are: the rise in subvented lending performance projections from pool to pool. from the captives, as these loans are generally extended to higher credit quality obligors; the New vs. Used Vehicles decrease of “C” and “D” quality loans in bank and The market for used vehicles has grown rapidly over captive portfolios and, if not a decrease in used car the past couple of years and should continue to financings, a focus on one- to three-year old higher account for a significant percentage of the overall end vehicles with greater recovery value. Because retail finance market. Reasons for this include: new of these patterns, Fitch IBCA expects loans vehicle prices are rising faster than used vehicle originated in 1998 and 1999 to outperform those of prices, making used vehicles more attractive to earlier years. consumers; less of a stigma is attached to purchasing a used car, since these vehicles are now more reliable Composite Cumulative Net Losses for Securitized Pools 1995–1998 (%) 3.00 2.75 2.50 2.25 2.00 1.75 1.50 1.25 1.00 0.75 0.50 0.25 0.00 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 1995 1996 1997 1998 A Map to Rating Auto Loan-Backed Securitizations 3
    • Structured Finance and last longer; and an abundant supply of off-lease Typically, as the downpayment increases, defaults vehicles. Also, the new vehicle sales market has should decrease due to the reluctance of the borrower become extremely competitive, and the profit margin to forfeit equity in the vehicle. However, Fitch IBCA in this market is slim, compared with that of the used has seen evidence supporting and refuting the vehicle market. perceived “equity link” in the vehicle, although in the prime sector, the connection seems more established Several years ago, when Fitch IBCA observed an than in subprime. The bottom line seems to be the increase in the number of used vehicles in more equity the better, as loss severity will be lower securitization pools, the general consensus was that in the event of repossession. used vehicle loans performed similarly to new vehicle loans. This was based on the theory that, Advance Rate while used vehicle loans had a higher frequency of Fitch IBCA analyzes the advance rate, defined as the chargeoffs than new vehicle loans, loss severity was loan balance as a percentage of the manufacturer’s lower due to the depreciation that the vehicle had suggested retail price, in various ways. The advance already experienced. rate may exceed 100% due to soft and hard add-on items. Hard add-ons consist of actual items on the However, recent experience demonstrates that, all vehicle, such as a compact disc player or sunroof. else being equal, used vehicle loans will experience Soft add-ons are items such as loss accident, and higher delinquencies and losses than new vehicle health insurance and extended warranty, which are loans. Interest rates on used loans generally reflect rebatable in the event of default. the higher risk but provide little benefit under high loss scenarios. Fitch IBCA has also witnessed a move First, Fitch IBCA will consider the appropriateness of toward one- to three-year-old vehicles and lower the lender’s underwriting and advance rate guidelines. advance rates on these loans. When examining a Generally, advance rates are less important in the securitization pool, Fitch IBCA looks closely at the new analysis of prime borrowers than with subprime versus used mix and how it has changed over time. This borrowers, given the relatively lower probability of way, the relative impact of used vehicle loans on an default and repossession. Nevertheless, guidelines issuer’s prior pools can be measured. Fitch IBCA should have specified maximum advance rates that prefers to examine static pool loss data that distinguish mitigate the loss in the event of repossession. between new and used for greatest accuracy. Second, Fitch IBCA will examine the overall Downpayment advance rate on the pool versus that of prior pools. If Fitch IBCA considers the downpayment amount on an issuer had an overall advance rate on a prior the vehicle, as well as the total amount of the loan as securitization of 110% and the pool being securitized a percentage of the wholesale cost of the vehicle. has an advance rate of 115%, for the same frequency Oustanding Balance of Loan* Estimated Depreciation Value 36 Months 48 Months 60 Months ($) 20,000 18,000 16,000 14,000 12,000 10,000 8,000 6,000 4,000 2,000 0 0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32 34 36 38 40 42 44 46 48 50 52 54 56 58 60 *$18,000 loan. Assumes a 10% annual percentage rate. A Map to Rating Auto Loan-Backed Securitizations 4
    • Structured Finance of repossession, losses would be expected to rise as a higher risk profile are assessed a higher interest rate result of the increased loss severity. Alternatively, as part of a lender’s tiered pricing strategy. However, even two pools with similar overall advance rates one pool is not necessarily riskier than another if the may demonstrate different losses because of different overall pool APR is higher. The interest charged the advance rate distributions. For example, if two pools customer is also a function of the market had overall advance rates of 110% each, but one pool environment. Therefore, two otherwise identical had a greater percentage of loans with very high pools originated by the same issuer may have advance rates, adverse selection could result in a different APRs as a result of the interest rate disproportionate number of chargeoffs among high environment at the time of origination. It is also advance rate loans, which could lead to different loss important to consider the distribution of APRs on the expectations for otherwise identical pools. loans. For example, loans with very low APRs may be subvented, or incentive, loans. Incentive loans Depreciation carry interest rates at a below-market rate due to Recoveries and ultimate losses may vary due to financial support provided by either the vehicle differences in depreciation. With respect to the Big manufacturer or the captive finance company. Although Three, Chase, Honda, and KeyCorp, these lenders’ these loans have been extended to more creditworthy portfolios exhibit excellent make and model borrowers, they may decrease the availability of excess diversification and, therefore, stable depreciation rates spread over time. Typically, a securitization containing a and subsequent recoveries. However, some independent significant concentration of incentive loans will include finance companies may not have the same such a yield supplement account or similar feature to ensure diversification as the captives and large national full and timely noteholder payments. Lastly, it is banks. Portfolios with insufficient make and model important to examine the percentage of loans with diversification are exposed to risks such as vehicle high coupons, as these loans could indicate subprime recalls or other quality-related problems that may cause or nonprime customers that tend to charge off at a a particular manufacturer’s vehicle to rapidly depreciate. much higher rate than the overall pool, thereby depleting excess spread. Loan Term Distribution Most securitizations will consider a loan eligible for Geographic Diversification securitization only if its original term is 60 months or A pool of loan receivables should exhibit geographic less. Loan terms of up to 72 months are occasionally diversification to minimize its exposure to regional allowed but typically will be limited to a small economic downturns. The Big Three and Chase percentage of the total pool, as losses tend to rise as portfolios are good examples of well diversified the loan term increases. This may reflect credit portfolios, although most prime issuers have a underwriting, which relies on payment-to-income national focus. With the increased securitization ratios. Borrowers with low income will qualify only activity of regional banks and independent finance for loans with low payments, which is typically companies, Fitch IBCA has seen more geographic achieved by lengthening the contract term. Another concentration in these portfolios and closely risk of extended term loans is that principal will examines the measures each lender takes to minimize amortize more slowly, thus increasing loss severity in portfolio exposure to local economic events. Fitch the event of borrower default. The chart at the top of IBCA focuses on available management reports to page 4 highlights the depreciation curve for a determine how a lender’s various geographic regions standard midsize vehicle, combined with the perform. To date, Fitch IBCA has not seen significant amortization schedule of a 36-, 48-, and 60-month disparity in the loss and delinquency figures by contract. The car is assumed to sell for $18,000, and region for any given lender. the loan amount is also assumed to be $18,000. As illustrated early on in the deal, the equity gap is Most lenders are aware of their portfolio’s vulnerability considerably larger and lasts longer as the loan term to regional downturns and have customized credit increases. In addition, when analyzing two pools of scorecards to compensate for this risk. Caution should loans with similar original loan terms, the distribution of still be used since state concentrations can affect cash such terms should be considered, as there tends to be a flows from a securitized pool of auto loans, disproportionate number of chargeoffs among extended particularly in states with onerous repossession term loans. requirements. For example, Fitch IBCA has noted several instances where credit enhancement draws Annual Percentage Rate were necessary due, in part, to difficulty in receiving Fitch IBCA considers the total annual percentage rate vehicle liquidation proceeds with respect to vehicles (APR) of the pool, as well as the distribution of in Arkansas and Louisiana. Complying with the APRs, in its analysis. In general, borrowers with a relevant laws in these states results in full balance A Map to Rating Auto Loan-Backed Securitizations 5
    • Structured Finance chargeoffs where principal is due for the full loan Fitch IBCA will analyze the variables constituting balance, but recoveries have not yet been received. each lender’s scorecard and consider how and why Consequently, full-balance chargeoffs usually lead to these variables have changed over time. Fitch IBCA liquidity strains and credit enhancement draws if also takes into account how often scorecards are losses escalate. validated to ensure that the cards maintain predictive validity. Furthermore, Fitch IBCA will examine how s Operational Review often the credit score-dictated decision is overridden and the process to evaluate overrides. Overrides can Underwriting occur in two ways — individuals who score below Fitch IBCA’s underwriting analysis focuses on the cutoff score but are accepted and those who score quality and consistency. Fitch IBCA strives to ensure above the cutoff but are rejected. The reasons for the that credit characteristics of the receivables that overrides should be well documented, and the produced the base case loss estimate (see Credit performance of the overrides should be monitored Analysis, page 8) are similar to those in the pool over time. Performance data on overrides should then being securitized. The structure of the finance be used to refine acceptance criteria. contract is also reviewed. Ultimate loss is a function of frequency of default and severity of loss. The Recently, issuers have been able to provide Fitch credit characteristics of the borrower largely dictate IBCA with static pool loss data segmented by credit the frequency of default. Advance rates allude to the score. Providing the scorecards are validated on a severity of loss. Hence, even if borrowers are routine basis, Fitch IBCA has found such data to be defaulting with the same frequency, losses can rise an extremely useful tool for estimating future pool due to increased loss severity associated with higher performance on a relative and absolute basis, advance rates. although care must be taken to account for and understand the potential impact of credit score The majority of originators use credit scorecards to changes on future performance. With this type of assist in the underwriting process. Credit scoring is a information, Fitch IBCA can adjust credit enhancement method by which a large sample of defaulted loans is levels to reflect the credit score distribution of the analyzed to determine which variables are pool being securitized. statistically significant predictors of default. Scoring allows for the efficient and accurate credit assessment Seller/Servicer Risk of numerous applicants. The information used in the In prime auto transactions, the seller and servicer are scorecards can be gathered from either the borrower’s almost always one in the same, and the financial credit report or the loan application. The variables strength of these entities always plays a pivotal role and weightings are used to determine a credit score in every structured finance transaction. The servicing for each applicant. This score is typically combined function is one of the most critical aspects of loan with the judgment of an experienced credit analyst, performance. Fitch IBCA has witnessed several cases who makes the final decision. Generally, those where pools with nearly identical underwriting individuals scoring above a predetermined cutoff criteria produce different loss numbers due to score are recommended for acceptance, and those servicing capabilities. Moreover, a disruption or scoring below recommended for denial. Lenders may transfer in servicing, no matter the length, will impair also use multiple scorecards to analyze performance performance. Consequently, careful attention is paid to a among different geographic regions or to compare the servicer’s financial strength and ability to accommodate performance of first-time car buyers with repeat growth, collection, and repossession procedures, as buyers. well as chargeoff policies. In the case of prime lenders, risk of a disruption is partially offset since Many lenders rely solely on information derived from the majority maintain strong investment-grade ratings the credit bureau report, as this information tends to by Fitch IBCA. be more accurate and reliable than application data. In addition, information such as loan structure and In cases where the seller/servicer is not rated by Fitch advance rates may not be as important in the analysis IBCA, audited financials are reviewed to understand of the prime borrower as for the subprime borrower. a company’s funding alternatives, existing corporate The focus of the underwriting process for the prime debt structure, warehouse and bank facilities, and the borrower is on credit, which is different than underwriting underlying motivation for securitization to assess a for subprime borrowers, where the collateral information transaction’s viability. Full due diligence is then is critical given the higher likelihood of repossession. performed by a team of Fitch IBCA analysts from the Structured Finance and Financial Institutions groups before a rating is assigned to a securitization. A Map to Rating Auto Loan-Backed Securitizations 6
    • Structured Finance Repossession Timeline Condition Report; Disposition NOI Order At Collections Efforts/Assignment Repossession Expires Repo Title Receive Title Auction 60 Days 75 Days 95 Days 105 Days 1125 Days 130 Days 0 10 20 30 40 50 60 70 80 90 100 110 120 130 NOI – Notice of intent to repossess. Collections of an original contract term. Thus, a 48-month contract The collections process should be flexible enough to could receive no more than four one-month extensions allow the borrower sufficient time to correct over its life. Fitch IBCA is aware of the pitfalls whatever problem led to delinquency yet must associated with these tactics as short-term fixes for provide that repossession commences quickly when delinquencies and scrutinizes the extension policies nonpayment becomes inevitable. Most collection of each lender; however, prime lenders tend to departments are organized in one of two ways — employ this strategy infrequently. stage of delinquency or cradle-to-grave. Departments organized by stage of delinquency typically have Repossession and Disposition junior collectors on early stage delinquencies and The chart above depicts a repossession timeline for a senior collectors for more serious late-stage representative prime lender. Fitch IBCA pays careful delinquents. These senior collectors are the last attention to each point on this line, as disruptions can opportunity the borrower has to work out the problem influence recoveries on repossessed collateral and before repossession. Departments organized with a interrupt payments to securityholders. First, Fitch cradle-to-grave philosophy will have one collector IBCA examines when the vehicle is assigned for work an account from its earliest stage of delinquency repossession and considers how much collection until assignment for repossession. The thought behind effort the account has received prior to assignment such a structure is that the collectors will develop a for repossession and if the borrower has had ample rapport with the borrower, become familiar with his opportunity to bring the account current. or her individual circumstances, and, thus, be more Repossession should only be considered a last resort. likely to develop a cure for the delinquency. While this argument may have some merits, it has been Next, it is important that the vehicle be located and Fitch IBCA’s experience that more seriously repossessed as soon as possible. Provided that the delinquent accounts require the skills of experienced, borrower is not hiding the vehicle or has not seasoned collectors to bring the account current. “skipped,” a fully licensed and bonded repossession agent should be able to locate and repossess the As prime customers have more options and means vehicle in a matter of days. Finally, Fitch IBCA available to solve their delinquency, collection efforts focuses on the time it takes from repossession to need not commence on the first day of delinquency, ultimate sale. It is important that vehicles be sold as as is typically the case with subprime borrowers. A quickly as possible to maximize the recovery on the recent study by one bank showed that nearly 50% of vehicle and lower carrying costs. Cars left to accounts one day delinquent cured themselves by the depreciate on auction lots will have significantly 20th day. Consequently, the bank found that the lower recovery values, adversely affect loss severity, efficiency of its collectors was maximized by not and strain liquidity in the deal. commencing any collections activity until accounts were 22 days past due. Generally, most finance Fitch IBCA prefers that repossessed vehicles be companies dealing with high-quality borrowers begin disposed of through wholesale auctions with a collections activity between 15–25 days past due. company representative on site. While the ultimate recovery will be lower than if the vehicle were sold Extensions on a retail basis, Fitch IBCA has noticed that the Loan extensions or deferrals can be a valid method of wholesale disposition of repossessed vehicles tends curing delinquencies for borrowers who have to be a more efficient and predictable means of suffered temporary unemployment or some other receiving recoveries. Retail disposition, whereby unexpected financial hardship. Extensions allow the vehicles are sold on used car lots, can result in loan to become current by adding another month to lengthy delays in the receipt of recoveries. In the remaining term. To qualify, borrowers must not addition, any benefit of retail channels may be offset have been delinquent for the past six months and are by increased depreciation during the potentially typically limited to one extension for each 12 months extended sales period. Securitization performance A Map to Rating Auto Loan-Backed Securitizations 7
    • Structured Finance can suffer in the event of substantial delays in the amount it is still owed after the sale of the vehicle. receipt of vehicle liquidation proceeds. Fitch IBCA will consider each lender’s historical experience with respect to pursuing deficiency Chargeoff and Recovery judgments and incorporate these recoveries into the The performance of auto securitizations depends lender’s loss severity analysis. heavily on an efficient repossession and recovery process. The documentation supporting each securitization trust s Credit Analysis specifies when a loan is deemed defaulted and the full principal balance then due to the trust. This Static Pool Analysis typically occurs 120 days after initial delinquency. The essence of Fitch IBCA’s credit analysis lies in Recovery proceeds from vehicle disposition usually interpreting static pool loss data. Static pool data are flow through to the trust within the next month. The useful in determining the magnitude and timing of issuer’s internal policies and procedures must be losses and provide one of the best indications of how consistent with the trust documentation to minimize the underlying loans will perform under stress. Data the effect of full balance chargeoffs and prevent are either directly provided by the issuer or are culled delays in payments to securityholders. Full balance from prior securitizations. While data from existing chargeoffs occur when the full principal balance of securitizations are useful, information provided the loan is due to the trust and the recovery amount directly by the issuer is often more detailed and, associated with the sale of the vehicle has not been therefore, superior. In the past, issuers have been able obtained. If the servicer is unable to complete the to provide Fitch IBCA with detailed static pool repossession process in the time required by the trust analysis, capturing portfolio performance by new and documentation, credit enhancement must make up the used vehicles, loan term, credit score, and even shortfalls. If full balance chargeoffs are a high vehicle type. This analysis is critical in helping Fitch percentage of total defaults, excess servicing strains IBCA understand the unique loss drivers associated and credit enhancement draws could pressure transaction with each issuer’s portfolio and helps provide the liquidity and disrupt payments to bondholders. most accurate loss projection and credit enhancement levels for each securitization. Fitch IBCA stress scenarios anticipate and provide for this occurrence. As a general rule, Fitch IBCA Relying solely on historical static pool information to will assume delays in recoveries associated with gauge future losses would be sufficient if the past charged off loans. The assumed delays will vary by were a perfect predictor of the future. However, static issuer but range between three and five months. pools capture performance over a specific period and, thus, will have unique macroeconomic factors After the vehicle has been repossessed and sold, a influencing their outcome. Consequently, it is deficiency judgment is obtained by the lender for the important to evaluate the economic conditions Weighted Average Cumulative Net Loss Curves Premier AFG Honda (%) 14 12 10 8 6 4 2 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 Months Since Origination A Map to Rating Auto Loan-Backed Securitizations 8
    • Structured Finance Lifetime Loss Distribution for Prime Auto Loan Pool (%) 100 90 80 70 60 50 40 30 20 10 0 1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41 43 45 47 Months present for the period captured with each static pool. tend to default earlier in the life of a loan and with Changes in underwriting guidelines also affect pool greater frequency. performance, rendering it equally important to understand the changes made to underwriting The chart above contains a representative sample of guidelines over time and to adjust current loss the percentage of cumulative net losses experienced expectations as appropriate. since securitization for a prime issuer. Frequent securitizers, such as Chrysler and Ford, come to After considering all the factors detailed above, Fitch market several times a year. Accordingly, these pools IBCA will determine its base case loss expectation. typically have limited seasoning. As is illustrated, the For conservatism, Fitch IBCA’s base case estimate loss curve is very quiet in the early months. However, will usually be derived from the static pools with the occasionally, issuers will look to securitize pools that highest loss figures rather than an arithmetic average. are well seasoned. Credit enhancement requirements However, if significant improvement has occurred or a for such pools will typically be lower than for a pool appears to be an outlier, this will be considered in newly originated pool, as a portion of the ultimate the analytical process. To gauge loss volatility, Fitch losses on the pool has already occurred. The amount IBCA relies on many factors, including sample of credit given for such seasoning is a direct function standard deviation. of the originator’s historical static pool loss history and loss volatility, as well as the amount of seasoning Loss Speed on the pool. Moreover, an examination of loss speed The graph on the bottom on page 8 captures static enables Fitch IBCA to project ultimate losses on pool information for three frequent securitizers, pools that have not yet reached maturity. However, American Honda Finance Corp. (AHFC), Chrysler due to variances produced by different underwriting Financial Corp., and AutoFinance Group (AFG). and servicing standards, Fitch IBCA relies on a AFG was acquired by KeyCorp in September 1995 statistical evaluation of each lender’s unique loss and renamed Automotive Specialty Finance. The distribution for cash flow modeling purposes. company remains the specialty finance arm of Key Bank USA, N.A. The static pool information Stress Multiples presented is a weighted average of cumulative net After considering the aforementioned items, Fitch losses for all pools since the month that they were IBCA determines its base case level of cumulative securitized. The information presented for the Honda net losses over the life of a representative pool of and Chrysler pools is typical for pools consisting of loans. The base case is generally associated with a ‘B’ highly creditworthy borrowers. The AFG loans rating category. Stresses outside the standard multiples represent loans to individuals with prior credit are lender-specific and are a function of servicing problems and are common for companies in this ability, historical loss volatility, availability and amount sector. As is evident, less creditworthy borrowers of static loss data, portfolio growth, and collateral A Map to Rating Auto Loan-Backed Securitizations 9
    • Structured Finance composition. For prime auto loans, Fitch IBCA has used Sources of Credit Enhancement ‘AAA’ stress multiples ranging from 4.5 times (x) to Considerable discussion has been devoted to how Fitch 6.0x the base case loss estimate. The ‘A’ stress multiples IBCA assesses loan quality and uses static pool loss data have ranged between 2.5x –3.5x the base case. to derive its base case loss estimate and loss coverage requirements for each rating category. Next is the As demand for higher yielding securities grows, evaluation of the sources of credit enhancement. many investors are favoring subordinated tranches from stable, higher rated issuers over riskier The primary forms of credit enhancement used in nonprime and subprime transactions from non- securitizations with internal credit enhancement are investment-grade entities. As such, Fitch IBCA has excess spread, reserve accounts, subordination, and been asked to rate down to ‘BBB’ and ‘BB’ levels on overcollateralization. Transactions that use guarantees prime securitizations with greater frequency. While from the monoline bond insurers are not considered, since the credit analysis for these securities is similar to these transactions derive their rating directly from the higher rated classes, the dependency on excess spread rating of the monoline bond insurers that guarantee timely for credit enhancement is far greater. In fact, it is not payment of principal and interest on the bonds. uncommon for a ‘BB’ rated class to be supported solely by excess spread. Loss multiples for these rating As might be expected, not all forms of credit enhancement categories range from 2.0x–2.5x base case cumulative offer investors the same level of protection. Furthermore, net losses for ‘BBB’ and 1.0x–2.0x for ‘BB’. enhancement levels often vary among securitizations by the same issuer. For example, an issuer securitizing a collateral s Structural Analysis pool with a greater percentage of used vehicles than prior Fitch IBCA’s analysis of auto securitizations focuses securitizations is likely to have increased credit primarily on the credit characteristics of the underlying enhancement requirements, as used vehicle loans typically receivables. Fitch IBCA has analyzed a multitude of have higher and more volatile losses than new vehicle structures and is generally able to approve most structures loans. Similarly, a higher percentage of incentive loans will where the multiple of losses being covered is consistent likely decrease enhancement needs. with the desired rating. As the structuring alternatives available to issuers continue to grow, Fitch IBCA focuses The following section outlines how Fitch IBCA analyzes its analysis on the credit of the underlying receivables and the major forms of internal credit enhancement used in allows the issuer to determine the most efficient structure. auto securitizations. However, once a structure has been selected, Fitch IBCA Excess Spread creates a custom cash flow model for each transaction to The amount of credit given for excess spread as credit ensure that under deteriorating conditions the asset cash enhancement in Fitch IBCA’s stress scenarios is streams and integrity of the structure are sufficient to influenced by the following: pay investors in full. Excess Spread as Credit Enhancement Collateral Balance 250,000,000 Weighted Average Collateral APR 11.50% Weighted Average Original Term 54 Months Servicing Fee 1.00% Weighted Average Remaining Term 54 Months Weighted Average Bond Coupon 6.50% Base Case Cumulative Net Losses 2.25% Recovery Rate 50.00% Prepayment Assumption (ABS) 1.00% Recovery Delay 3 Months Collateral Model Run Description Required Loss Hard Credit Available Average Life Coverage (%) Enhancement (%) Excess (%) (Years) Base Case Losses/Delinquent Interest/ WAC Compression/No Prepayments N.A. N.A. 7.91 2.44 Base Case Losses/Delinquent Interest/ WAC Compression/Prepayments 2.25 0.00 6.39 1.98 'A' – 3 Times Base Case Losses/ Delinquent Interest/WAC Compression/Prepayments 6.75 2.25 5.34 1.89 'AAA' – 5 Times Base Case Losses/ Delinquent Interest/WAC Compression/Prepayments 11.25 8.50 3.69 1.78 APR – Annual percentage rate. ABS – Absolute prepayment speed. WAC – Weighted average coupon. N.A. – Not applicable. A Map to Rating Auto Loan-Backed Securitizations 10
    • Structured Finance Delinquent Interest: The impact of delinquent collateral tends to exhibit increasing prepayments as borrowers on the stated APR is assessed for every loans season, a trend CPR does not capture. issuer. As a servicing report is essentially a detailed static pool analysis, Fitch IBCA examines servicer Average Life Reduction: High stress multiples reports to capture the actual APR (calculated on the decrease the average life of the pool, reducing excess basis of interest received) versus the stated APR. The spread over the life of the transaction. Since voluntary results of this analysis are incorporated into Fitch prepayments are held relatively constant, average life IBCA’s cash flow models. As would be expected, is primarily reduced through high defaults. delinquencies are a precursor to losses and, therefore, are similarly distributed. Delinquencies tend to be Captured Excess Spread: Excess spread is modeled highest in the first year or two of a pool’s life and on a “use it or lose it” basis. Fitch IBCA models will diminish by the third year. Fitch IBCA assumes incorporate reserve fund and overcollateralization targets. 0.50%–0.75% delinquent interest for year one and However, after consideration of the items listed above, then 0.25%–0.50% in subsequent years. These these targets are typically not as important as the stresses are generally adjusted by rating category. initial deposit. This is because, under stress scenarios, excess spread is usually exhausted. While servicer advances help alleviate this problem and provide needed liquidity, Fitch IBCA generally does not The example on page 10 demonstrates how much give credit for servicer advances. They are usually the credit enhancement would be needed for ‘AAA’ and first item to be paid out of the waterfall in subsequent ‘A’ ratings and how much excess spread might be collection periods and, thus, provide no real credit available to cover losses in a typical sequential-pay protection. In addition, most servicers are rated lower auto loan securitization. General loan and bond than the rating carried by the most senior bond. information for the securitization with limited seasoning is shown. Base case cumulative net losses Weighted Average Coupon Compression: A large are assumed to be 2.25% and recoveries 50%, with a percentage of high interest rate loans along with a three-month delay to recovery. Voluntary wide distribution of rates can cause a pool’s interest prepayments are held constant at 1.0% ABS. To collections to decline over time due to involuntary achieve ‘AAA’ and ‘A’ ratings, 11.25% and 6.75% and voluntary prepayments. Analysis of the loss coverage is needed, a portion of which could be receivables pool and servicing reports allows Fitch funded from excess spread. IBCA to identify pools of loans that may be vulnerable to weighted average coupon (WAC) compression. In the absence of prepayments and losses, available Fitch IBCA has observed that pools with a large excess spread is 7.91% over the life of the collateral. number of incentive loans exhibit WAC compression. However, in a stress scenario, excess spread would Voluntary prepayments on these loans are low, as the be significantly reduced by delinquent interest, WAC incentive to prepay is minimal. In addition, borrowers compression, prepayments, and losses. As shown, with high creditworthiness ordinarily qualify for available excess spread drops as low as 3.69% as stress these loans, resulting in low involuntary prepayments is applied and the average life of the pool shrinks. as well. Therefore, over time, most total prepayments The decrease in the average life is a direct on the pool will come from the higher interest rate consequence of the increase in the default rate. loans, which will tend to move the portfolio’s overall WAC closer to that of the subvented loans, resulting in Reserve Account less available excess spread to cover losses. Most auto securitizations use spread or reserve accounts, which are typically funded with an initial Prepayments: Fitch IBCA will examine prepayment deposit and trap excess spread up to a required experience for issuers by collateral type, term, and rate amount. Spread accounts are useful for meeting to determine the likelihood of voluntary prepayment transaction expenses and providing liquidity, which and the potential for adverse selection. Once a speed may be strained during periods of high losses. Fitch has been determined, it is incorporated into cash flow IBCA’s main emphasis in sizing spread accounts is models and is generally held constant unless data on the initial deposit, not the target amount, as the suggest otherwise. As noted above, high prepayments initial deposit typically dictates the minimum level of will reduce the average life of the securities, generate losses a securitization can withstand at closing when less excess spread, and potentially require higher levels the rating is assigned. Under high loss scenarios of hard credit enhancement. Fitch IBCA models where losses are front-loaded, excess spread is prepayments using either the absolute prepayment depleted before the reserve account reaches its target. speed (ABS) or the constant prepayment rate (CPR) assumption. ABS is the preferred method, since auto A Map to Rating Auto Loan-Backed Securitizations 11
    • Structured Finance Chase Manhattan Auto Securitization Prepayment Speeds* (ABS) 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% 01 03 05 07 09 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 Months Since Origination 1995-A 1995-B 1996-A 1996-B 1996-C 1997-A 1997-B 1998-A 1998-B 1998-C *ABS speed is a three-month rolling average. Generally, for each month the securitization performs protection than a cash reserve account, since they at or better than the base case projection, ongoing depend on available collections. loss coverage multiples improve. This partly reflects the fact that a substantial portion of portfolio losses Whatever credit enhancement form is chosen, will occur in the first year. If the reserve account detailed cash flow modeling is essential to properly target is reached, a greater amount of credit evaluate each and to ensure that the appropriate enhancement is available to cover expected protection for the desired rating category is achieved. remaining losses, and the ongoing multiple of losses the transaction can withstand is significantly greater Owner Trust vs. Grantor Trust than it was at day one. A nondeclining reserve will The two dominant structures in auto loan securitization further boost the available credit enhancement. are grantor and owner trusts. Grantor trusts require principal distributions on underlying securities to be Fitch IBCA assigns its ratings based on the level of made on a pro rata basis. As such, in the absence of loss protection available at day one and available losses, the senior and subordinate classes in a grantor excess spread trapped. Most reserve accounts are trust will have the same average life. However, in an sized to reach their target in six to nine months under owner trust, cash flows can be allocated in any base case loss expectations. manner stipulated by the deal documents. There are also differences in the tax treatment of the two trusts, Subordination/Overcollateralization but these issues are not credit related. As long as an Subordination and overcollateralization (OC) are entity level tax does not exist on the trust, the amount considered together as they both represent an of cash available to bondholders is unaffected. ownership interest in the underlying receivables and, from a cash flow perspective, behave similarly. If an Owner trusts allow for the creation of tranches with investor’s pro rata share of collections is insufficient specific payment characteristics and varying average to make scheduled payments, funds otherwise lives. Tranching is a useful method of enhancing the payable to the seller or to junior bondholders are used attractiveness of a trust’s securities to a wider to pay senior bondholders. investor audience. For example, in the typical grantor trust transaction, senior investors usually only have Pure overcollateralization consists of an ownership the option of purchasing a bond with an average life interest in the receivables retained by the seller and of approximately 1.5–1.7 years and are limited to two does not have a coupon expense associated with it. tranches. However, senior investors in an owner trust Subordinate tranches typically have coupon expenses can usually chose among bonds with average lives of and, therefore, will result in less cash for senior between 0.25–4.00 years. bonds than OC. Both will generally offer less credit A Map to Rating Auto Loan-Backed Securitizations 12
    • Structured Finance Another feature of owner trusts is the use of excess s Legal Issues spread as additional principal. Excess servicing can As with other ABS transactions, retail auto be reallocated to pay down the note balance in each securitizations are structured to isolate the auto loans period (full turbo) or until a specified level of from the bankruptcy or insolvency risks of the other overcollateralization is achieved (partial turbo). entities involved in the transaction (auto loan seller Overcollateralization is created since the securities and/or originator). This is typically accomplished by are being amortized faster than the collateral pool. the seller/originator transferring the auto loans (either When determining credit enhancement requirements directly or indirectly depending upon the chosen in owner trusts, Fitch IBCA focuses on the level of structure and the type of entity making the transfer) overcollateralization available at the beginning of the by means of a “true sale” or series of “true sales” to transaction, not the target overcollateralization one or more “bankruptcy-remote” entities, one of percentage. Fitch IBCA considers this appropriate and which will ultimately issue the asset-backed conservative, since, under stress scenarios, the securities to the investors. In cases where a FDIC- overcollateralization target is never reached, although insured bank or another bankruptcy-remote entity is credit is assigned to what is achieved. transferring the auto loans to a bankruptcy-remote entity, such transfer may take the form of a first From a credit perspective, Fitch IBCA does not priority perfected security interest. Furthermore, if differentiate between the loss expectation of an the bankruptcy-remote issuer is issuing debt owner trust versus that of a grantor trust. The losses securities, those debt securities should be secured by on the transaction do not determine cash flow the grant of a first priority perfected security interest allocations to investors. Nevertheless, the structural from the bankruptcy-remote issuer to the indenture characteristics of an owner trust could lead to lower trustee for the benefit of the debt holders. credit enhancement requirements than a grantor trust. Consider an owner trust in which the subordinate For an entity to be considered bankruptcy-remote, class is locked out of principal until the senior class is Fitch IBCA generally requires that it be a so-called paid in full. In this structure, available credit protection special purpose entity (SPE). An SPE can take many would increase over time. This structural protection forms (corporations, limited liability companies, and mechanism leads to lower credit enhancement trusts, among others.). However, no matter what type requirements than a typical grantor trust structure. of organization the SPE is, the SPE should be formed and operated in ways designed to mitigate the Owner trusts also have unique structural features that likelihood of both voluntary and involuntary must be incorporated into the cash flow. For bankruptcy. A properly structured SPE should have example, many owner trusts incorporate a money restriction on its powers, its ability to incur debt and market tranche that the issuer desires to be eligible to pledge its assets and to merge or reorganize. In for money market investors under Rule 2a-7 of the addition, the SPE should be bound by a series of Investment Company Act of 1940. Consequently, it is covenants that are designed to maintain its necessary for this bond to have a legal final maturity “separateness” and thereby mitigate the potential that of no more than 13 months. Issuers typically want the the SPE and its assets could be substantively money market tranche be sized as large as possible, consolidated into its parent’s bankruptcy. since this bond will be priced off the lowest point of the yield curve, assuming the yield curve is upward To ensure that a retail auto securitization is sloping. However, Fitch IBCA limits the size of the appropriately structured to isolate the pool of auto money market tranche to the maximum that can be loans from the bankruptcy risk of other parties, Fitch repaid by the legal final maturity under Rule 2a-7 IBCA reviews the transaction documentation and using a 0.5% ABS prepayment speed and no losses. legal opinions. Legal opinions should address the nature of the various transfers in the transaction and The chart on page 12 depicts prepayment speeds on provide assurance that neither an SPE, nor its assets Chase’s auto securitizations. As is evident, there is and liabilities, would be consolidated with the assets considerable variability early in the life of each and liabilities of its parent, or of the other sellers transaction. At no point are prepayments less than 0.5% and/or originators of the auto loans, in any such ABS, a figure that Fitch IBCA considers representative party’s bankruptcy. With respect to transfers from the for sizing money market tranches. Fitch IBCA will sellers and/or originators of the auto loans to an SPE examine each issuer’s unique prepayment experience, (together with all of the transfers in between), the and higher or lower prepayment figures may be used legal opinions should state that the auto loans being to size money market tranches. transferred will not be property of the transferor’s bankruptcy estate in the event of such party’s bankruptcy or be subject to the automatic stay in such A Map to Rating Auto Loan-Backed Securitizations 13
    • Structured Finance bankruptcy. In addition, in many cases the legal Auto loans are also somewhat unique in that the sale opinions also should state that the pledge of the assets or assignment of security interest in the automobiles from an intermediate SPE to the issuer and from the is typically governed by certificate of title laws in the issuer to the indenture trustee for the benefit of debt applicable states. As a result, the sale of, and holders creates a first priority perfected security assignment of security interests in, automobiles are interest in the auto loans and their proceeds. noted on the title certificate for each automobile. Because of the expenses and difficulty of re-titling In addition, auto loans have certain distinctive automobiles, Fitch IBCA generally does not require features that require additional legal comfort beyond the certificate of titles to be amended to reflect the the traditional issues associated with the structure of subsequent assignments of the liens on the ABS transactions. Auto loans typically are automobiles to the various parties in the transaction. considered chattel paper under the applicable state’s However, in cases where there are material UCC. As chattel paper, both the sale of, and grant of concentrations of automobiles in particular states, a security interest in, the auto loans are perfected by Fitch IBCA generally requires local counsel opinions possession of the original documents or filing of to confirm that the issuer and the indenture trustee UCC financing statements. Consequently, either the will have a first priority perfected security interest in issuer or a custodian on behalf of the issuer or the the automobiles in those particular states. debt holders must possess the original documents or, more typically, UCC financing statements must be Finally, Fitch IBCA also typically requires that the filed to perfect the various transfers. The legal legal opinions address the tax status of the issuer in opinions should address the perfection of such the transaction. Such opinions should state that the transfers (whether as a sale or the grant of a security issuer would not be subject to federal tax or to state interest) among the various parties. or local taxes in all applicable jurisdictions. A Map to Rating Auto Loan-Backed Securitizations 14
    • Structured Finance A Map to Rating Auto Loan-Backed Securitizations 15
    • Structured Finance Copyright © 1999 by Fitch IBCA, Inc., One State Street Plaza, NY, NY 10004 Telephone: New York, 1-800-753-4824, (212) 908-0500, Fax (212) 480-4435; Chicago, IL, 1-800-483-4824, (312) 214-3434, Fax (312) 214-3110; London, 011 44 171 417 4222, Fax 011 44 171 417 4242; San Francisco, CA, 1-800-953-4824, (415) 732-5770, Fax (415) 732-5610 John Forde, Publisher; Madeline O'Connell, Director, Subscriber Services; Nicholas T. Tresniowski, Senior Managing Editor; Diane Lupi, Managing Editor; Paula M. Sirard, Production Manager; Jennifer Hickey, Andrew Simpson, Sandra Wagman, Igor Zaslavsky, Editors; Martin E. Guzman, Senior Publishing Specialist; Harvey Aronson, Publishing Specialist; Yvonne Y. Pak, Robert Rivadeneira, Publishing Assistants. Printed by American Direct Mail Co., Inc. NY, NY 10014. Reproduction in whole or in part prohibited except by permission. Fitch IBCA ratings are based on information obtained from issuers, other obligors, underwriters, their experts, and other sources Fitch IBCA believes to be reliable. Fitch IBCA does not audit or verify the truth or accuracy of such information. Ratings may be changed, suspended, or withdrawn as a result of changes in, or the unavailability of, information or for other reasons. Ratings are not a recommendation to buy, sell, or hold any security. Ratings do not comment on the adequacy of market price, the suitability of any security for a particular investor, or the tax-exempt nature or taxability of payments made in respect to any security. Fitch IBCA receives fees from issuers, insurers, guarantors, other obligors, and underwriters for rating securities. Such fees generally vary from $1,000 to $750,000 per issue. In certain cases, Fitch IBCA will rate all or a number of issues issued by a particular issuer, or insured or guaranteed by a particular insurer or guarantor, for a single annual fee. Such fees are expected to vary from $10,000 to $1,500,000. The assignment, publication, or dissemination of a rating by Fitch IBCA shall not constitute a consent by Fitch IBCA to use its name as an expert in connection with any registration statement filed under the federal securities laws. Due to the relative efficiency of electronic publishing and distribution, Fitch IBCA Research may be available to electronic subscribers up to three days earlier than print subscribers. A Map to Rating Auto Loan-Backed Securitizations 16