MIAMI — Recently issued subprime auto bonds rated below triple-A are at risk for downgrades in a hypothetical recession, according to a study conducted by rating agency DBRS. However, the risk is mitigated by built-in credit enhancement in auto securitizations’ structures, DBRS analysts told Auto Finance News.
DBRS’s study involved a simulation “similar in scope and length” to the Great Recession, said Hollie Reddington, vice president of U.S. ABS, global structured finance. The research found that only triple-A rated bonds were immune from the risk of a downgrade over a certain period. However, that risk was mitigated by certain assumptions the study was required to make, she said.
“We didn’t start the recession until month seven of the transactions,” Reddington said. “The way the structures work is there is a buildup of over-collateralization (OC) in the first six months for a lot of these types of deals, because the OC is building up to a target [amount],” she said, noting that when the recession kicked in during month seven, there were already protections built in that allowed these structures to work in subprime ABS investors’ favor. The model was based on a “typical ABS tenure” of three to four years, Reddington said.
“We took 2019-issued transactions and projected them going forward,” said Ines Beato, DBRS’s senior vice president of U.S. ABS, global structured finance. “Transactions that have been outstanding longer would theoretically have a higher credit enhancement as they’ve benefitted from further leveraging,” she said.
“One of the things that has protected auto loan securitizations overall is the way the structures are constructed — there’s credit enhancement that grows over time as a percentage of the amortizing pool balance,” Beato said, noting that from a ratings perspective, DBRS looks for a certain level of coverage of the losses the rating agency expects going forward.
“As our loss expectation either increases or stays stable, when you compare that to a growing percentage of credit enhancement over time, that leads to some ratings stability or higher losses being offset by an increase forward-looking credit enhancement,” Beato said.
DBRS has rated 19 trusts with auto receivables from Jan. 23 to Aug. 27, according to literature provided by the rating agency at the conference. Year-to-date, auto loan receivables make up 25.6% of its total rated transactions.
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