This week, shoe brand Toms abandoned the one-for-one shoe-giving promise that propelled it to success in the early 2000s in favor of a strategy focused on what it dubbed “grassroots good.” The new business model calls for the company to donate one-third of its profits to humanitarian organizations that focus on promoting mental health, ending gun violence and increasing access to opportunity.
While shoppers have long been interested in ethical brands, securitization investors are starting to pay attention to companies that take a stand on issues. These investors are gauging securitizers’ environmental, social and governance, or ESG, risk factors. The underlying premise is that companies that behave sustainably across a range of metrics will make better long-term investments. ESG investments might also align with investors’ attitudes toward issues like climate change or underserved borrower groups.
Within auto securitizations, environmental factors include carbon emissions, pollution and resource efficiency. Examples would include limiting loans with exposure to environmental issues or those that require certain protections from environmental risks, both of which could impact collateral values.
Social factors in auto ABS would relate to things like diversity policies, labor standards and community relations. Examples include loans whose origination practices are not biased toward any group or that provide lenders with excessive profit.
Governance factors include corporate administration, institutional strength and transparency. ABS examples include securitizations with adequate structural protections and procedures that protect all tranches.
Historically, ESG has been prevalent in equity investing, supporting companies that work toward a sustainable and equitable world. But it is starting to make a mark in the structured finance sector. Late last month, a pair of rating agencies explored the effects of ESG on auto-backed securitizations.
S&P Global issued a report that measures the auto securitization market’s exposure to ESG credit factors. It looks at the issues that shape an obligor’s capacity or willingness to meet financial commitments, such as borrower’ ability for repayment, collateral values, disruptions in servicing cash flows and increased regulatory risks. The upshot: Auto ABS has above-average exposure to environmental credit factors, average exposure to social credit factors and below-average exposure to governance credit factors.
Meanwhile, Kroll Bond Rating Agency’s report analyzed 11.9 million auto loans in 184 auto securitizations. KBRA hinged its data on the Environmental Protection Agency’s vehicle greenhouse gas (GHG) score, which reflects a vehicle’s tailpipe emissions of carbon dioxide, the most prevalent greenhouse gas. The EPA assigns a score to the majority of vehicle types for each model year, with scores ranging from 1 to 10. A score of 1 represents the highest amount of GHG emissions, and a 10 represents the lowest. KBRA was able to map 10 million of the nearly 12 million vehicles in the securitizations.
KBRA pointed out two main findings. First off, securitizations issued by Asian captives typically had a higher average GHG score compared with those issued by their U.S. counterparts. In other words, Asian captives’ ABS deals were backed by vehicles with lower emissions. Specifically, the ABS transactions for American Honda Finance, Hyundai Capital America, Nissan Motor Acceptance, Toyota Financial Services and World Omni Financial — which finances Toyotas for Southeast Toyota Finance — had average GHG scores greater than 6. On the flip side, issuance from Ford Credit and GM Financial had GHG averages below 5, according to KBRA. One of the main reasons for this discrepancy is that Asian captives typically finance fewer SUVs and trucks.
Second, lower income borrowers tended to finance vehicles with higher GHG scores, likely because they were more likely than affluent borrowers to finance sedans. As such, nonprime ABS securitizations often scored higher than prime securitizations. For instance, GMF’s nonprime ABS shelf had an average GHG score of 5.8, which was 1.4 points higher than the captive’s prime ABS shelf. Similarly, World Omni’s nonprime shelf had an average GHG score of 6.4 in its nonprime portfolio and an average score of 6.0 in its prime portfolio, according to KBRA.
Within securitization, ESG is in its early phases. TFS is the only lender to have issued green bond transactions, which the company defined as “instruments in which the proceeds are applied exclusively towards projects that promote climate change of other environmental sustainability initiatives.” TFS’s three green bond deals, issued from 2014 through 2016, were backed by loans made for green vehicles, such as gasoline-electric hybrids, electric vehicles and alternative fuel vehicles.
The only other financier whose securitizations could qualify as “green” is Tesla. The company’s lease securitization pools consist of 100% electric vehicle collateral, and the vehicles get the equivalent of 120 mpg, as well as the highest possible EPA smog ratings.
While green deals will likely pick up in the coming years with the increased financing of electric and hybrid vehicles, lenders would do well to give heed to ESG factors influencing ABS investors’ decisions.
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