Although every rating agency touted the resilience of auto securitization deals at ABS East 2017, the structures that protect investors from losses are weaker than they appear, Joseph Cioffi, partner at Davis & Gilbert, told Auto Finance News.
Rating agencies give a lot of weight to the protection known as overcollateralization, which is like stocking a savings account with enough money to survive several months of sudden unemployment.
Auto deals are more overcollateralized than the residential mortgage deals that crashed in the financial crisis — 5.5% for subprime ABS compared with 3.9% in RMBS. However, those mortgage deals were constructed on an assumption that the appreciating value of houses would provide an extra cushion for investors, whereas there is no such assumption for autos.
When the value of the assets were taken into account, mortgages were overcollateralized by 22% compared to less than 5.5%, and under 11% for subprime and deep-subprime auto ABS, respectively.
Of course, houses plummeted in value during the crisis, so investors also count on other tools to protect auto issuances from excess losses. However, those tools rely on an assumption that borrowers will continue to pay, and “I don’t think it will continue,” Cioffi said.
“The corollary to the assumption of never-ending real estate appreciation may be the presumed continued performance by auto loan borrowers,” he said in a blog post on Credit Chronometer, a website dedicated to the economic, market, and political events that shape the legal landscape and impact loan and credit markets. “There are a number of hazard signs on this front,” including depreciating used-vehicle values, household debt, student loan debt, the increased frequency of natural disasters due to climate change, and emerging alternatives to car ownership such as rideshare.
Cioffi said he doesn’t know how weak the structures are, but they’re “not as protected as people are touting them to be.”
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