The rise — and fall — of auto ABS spreads

COVID-19 has affected the health of the nation as well as the securitization market — for the moment. Pre-pandemic, auto-backed securitization volume was keeping pace with last year’s issuance, and spreads were tight. Despite slowing vehicle sales and origination, auto ABS volume in early March clocked in at $26.1 billion, up 11.1% year over year. GM Financial had already issued two securitizations, and other captives were on a similar track. Spreads on top-tier prime auto tranches were 13 basis points below swaps — a level unseen since 2015 — while spreads on BBB-rated subprime tranches were 101 basis points over swaps. By mid-March, though, the capital markets had hit the brakes, hamstringing ABS issuance. In a single week, subprime spreads for the highest-rated prime tranches ballooned 166 basis points — to 200 bps over swaps — while the BBB-rated subprime tranches soared 360 basis points to 500 bps over swaps. With interest in securitization dampened, auto financiers cobbled together a combined 10 securitizations in April and May, down from two dozen transactions in those months last year. But as the pandemic spread, rating agencies jumped into action, recalibrating methodologies and stiffening credit enhancement requirements to stem potential losses. Lenders, too, raised credit quality mandates, whetting investors’ appetites for auto ABS. Despite the economic and industry disruption, the auto sector’s fundamentals have remained largely intact. Vehicle values have regained momentum, with the Manheim Index shooting up to a record 146.1 in the first half of June after dropping to 125.8 in April. Vehicle sales have rebounded, too, as local governments eased lockdowns and allowed dealerships to reopen. The “surprisingly strong” V-shaped recovery in auto sales and used-vehicle values are evidence of pent-up demand and are “very positive developments for ABS performance,” according to a fixed-income strategy report from J.P. Morgan . Meanwhile, the number of extensions being granted by lenders across credit tiers is shrinking. In prime auto loan ABS, modification rates maxed out at 3.8% in May, compared with 12.1% in April and 12.4% in March, according to J.P. Morgan. For nonprime auto loan ABS pools, maximum modification rates declined to 12.5% in May, from 21.4% in April and 15.2% in March. Buoyed by those extensions, cumulative net loss rates continue to improve. In Kroll Bond Rating Agency ’s prime index, early-stage delinquencies in May fell 27 basis points year over year to 0.80%; in Kroll’s nonprime index, delinquencies dropped 140 basis points year over year to 6.97%, according to a June 16 report. As extensions ease, delinquencies and defaults will be poised to rise. Even so, credit performance should remain “notably better” than it was were during the Great Recession, primarily because of improved underwriting and stronger ABS structures, JPMorgan noted in its report. Spreads, too, already appear to have rebounded more quickly than they did during the Great Recession. It took 16 months for spreads on the highest-rated prime tranches to return to September 2008 levels. Meanwhile, in just four months, A-1-rated prime tranches priced at near pre-COVID levels. On June 18, the spread on A-1 tranches was 5 basis points below swaps, a single basis point shy of the Feb. 27 rate, according to J.P. Morgan. Subprime spreads have tightened at a slower pace; in the past two months, BBB-rated tranches have restored more than half of the spread gained since February. Still, chances are slim that auto-backed securitization volume will regain its original trajectory. As of mid-June, auto ABS volume was $48.9 billion, down 20.2% year over year. According to estimates, it is on track to shrink 23% by yearend. “We project $85 billion in auto ABS new issues for the full year 2020, compared to $111 billion last year,” J.P. Morgan wrote, adding that its year-end spread target for BBB-rated subprime auto ABS is 150 basis points. On June 18, spreads on BBB-rated tranches were 250 basis points above swaps. “Looking ahead to the second half of 2020, we expect strong technicals to remain in the driver’s seat for ABS spreads as the economy gets through the pandemic recession into recovery,” J.P. Morgan wrote. Yet, perhaps, the limited availability of securitized loans and leases could trigger spreads to rebound even quicker. With strong enough investor appetite for auto ABS, spreads may reach pre-COVID levels by late fall. Auto Finance Summit, the premier industry event, returns October 20-22, 2020, as a virtual experience. The virtual experience will offer the same quality networking and education as past events, all through an online platform. To learn more about the 2020 event and register, visit www.AutoFinanceSummit.com .

The rise — and fall — of auto ABS spreads

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