An increase of e-contracts to originate auto loans and leases has created a new source of legal and operational risk to auto asset-backed securitizations, according to a Moody’s Investors Service report.
Specifically, the use of e-contracts heightens potential risks related to the securitization trusts’ ownership of assets. A third-party could claim a superior interest in the loan or lease and divert expected securitization cash flows, Moody’s noted. While traditional paper contracts face similar risks, their legal framework differs from e-contracts and includes clear, well-established steps to mitigate those risks. E-contracts, on the other hand, must meet a number of specific criteria for ABS investors to maintain a right to payments on the loans and leases as well as valid liens on the underlying collateral, noted Moody’s Vice President Aron Bergman, one of the report’s authors.
Parties that might claim priority over the contracts include other presumed buyers in the case of duplicate sales of the same contracts; creditors in the case of bankruptcies of parties that have previously owned the e-contracts; and providers of floorplan financing to dealers, if they have not been repaid as required upon the sale of the assets.
Cyberattacks and other technical issues, such as system failures or bugs, also introduce risks for transactions backed by e-contracts, the report said.
However, Moody’s noted that various factors will likely continue to mitigate e-contract risks. Particularly, issuers can control access to e-contracts with electronic vault systems used to store contracts. Also, for financing secured through a dealership, allowing the ABS sponsor — rather than the dealer network — to obtain control of the e-contract mitigates the risk of the dealer’s creditor claiming a superior interest. Including small percentages in collateral pools also lessens risk exposure.
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