Auto ABS: uncertainty and excitement ahead | Dechert LLP – JD Supra – JD Supra | CarTailz

Recently, Dechert partner Sarah Milam participated in an Auto ABS panel discussion at ABS East in Miami, Florida. Sarah and four distinguished panelists discussed the state of the ABS auto loan market, issuance, yields, collateral performance, ESG trends and deal structure. Sarah sat down with Associate Griffin Hamilton to summarize the conference.

Gripping: How was ABS East?

Sarah: ABS East was great! People seemed generally in good spirits and not as gloomy as I’ve heard at some other conferences. People are still issuing, people are still doing business, people are finding new ways of doing business, and generally they are finding ways to adapt to market volatility and the difficult interest rate environment.

Gripping: Was the mood among participants and speakers good? Hungry for innovations?

Sarah: Yes, I think everyone is obviously concerned about what the near future holds and what’s on the horizon will certainly be a downturn. It’s already proving to be a challenging interest rate environment, but as we know from the previous crisis, asset backed securitization is less cyclical than other areas. Originators look to the future and opportunities for funding. Private investment and non-traditional securitization structures have expanded somewhat. A good chunk of ABS securitization has migrated into the 144A market; All of these factors contribute to more optimism than some other sectors, I think.

Gripping: Despite market volatility, overall ABS issuance, not necessarily auto ABS, is keeping pace with 2021 issuance, a record post-crisis year. Why do you think ABS is better than other bonds? Do auto ABS hold up as well as other asset classes?

Sarah: In general, what we call ABS: car, consumer, credit card, just hasn’t been hit that badly. We’re starting to see higher defaults in the auto industry, approaching pre-pandemic levels, but it’s only just beginning to translate into losses. As in the case of our broad asset classes, we’ve really benefited a lot from a strong first quarter, so this is really a continuation of 2021. I think a big concern is what the fourth quarter will bring. Q4 has traditionally been such a strong quarter. This year, it looks like it might not, as deal flow has slowed. That being said, there are many issuers who are required to issue; You have wealth and you have to find somewhere to put it. They still need to securitise to fund their business, particularly auto. It was a very strong car market in many ways. So, I really think the headline is that 2022 has kept up with the pace, but there are a lot of concerns about the fourth quarter, and I think everyone generally agrees that things are likely to collapse at some point will. So in a way people are just trying to push transactions now before that happens.

Gripping: Do you think another reason why ABS is holding up better than other securitizations is that the consumer is relatively strong?

Sarah: Consumers are still buying. We’re going to get to a point where people won’t buy anymore. We are just starting to see defaults but with the strong labor market etc we are not at the point where it is showing in losses yet. As consumer health and employment change, it will happen.

Gripping: Given the relatively short term of car loans, is auto ABS a good hedge against higher interest rates?

Sarah: Many people think that because of the high returns, there are many opportunities on the riskier side of transactions, such as B. Non-Investment Grade. Those who think the rate rhetoric is overblown see plenty of opportunity in sub-investment grade bonds. First-time buyers are demanding increased over-collateralization and reserves for new issues.

Gripping: How is the financial climate affecting spreads and prices?

Sarah: It’s wild. The difference between last year and this year is insane. Same issuer, same type of asset pool, and it’s like night and day. Deals are still being made because people have assets to sell. I think you’ll see people move away from pure securitization and 144A deals because there will be more attractive sources of capital — through whole-loan sales, forward-flow sales, particularly private debt buyers. I think private debt will be the front line once things change. There will be investors who continue to find these assets attractive. Private capital and alternative transaction structures have been the order of the day for some time and I think this trend will accelerate during the downturn.

Gripping: COVID-19 created global supply chain stresses and an influx of consumer funds, driving up demand for new cars and especially used cars. More recently, supply chain pressures are gradually easing, the used car market is cooling, interest rates are high and consumers are tight on cash. How is this affecting demand, new issuance, collateral performance and transaction structure?

Sarah: Arrears fell dramatically during COVID. Money was flowing into the economy, interest rates were low, people weren’t buying and selling their cars because they couldn’t. We are seeing this normalizing and getting back to pre-pandemic levels. Prime is holding up pretty well. Subprime a little less, but that’s exactly what you would expect. This was not a normal time in terms of casualties.

It is worrying that arrears have returned to pre-pandemic levels so quickly. I think the big question is when arrears will rise above pre-pandemic levels and how that will affect things. The question remains: what happens when some of these consumer issues strike? Especially with subprime. Depending on what is happening with the employment and the supply chain – many different factors. Subprime will always suffer greater losses than prime.

We also need to consider what will happen if used car prices fall, the supply of new cars increases and interest rates continue to rise.

Gripping: manual transmission, EVs are becoming a bigger part of the conversation every day. Do you see increased ESG prominence in the industry driven by the electrification push?

Sarah: I see an increased interest in ESG. There isn’t a huge difference in spreads or pricing for ESG bonds yet, and I think that’s partial Driven by the fact that there is little consensus on what exactly qualifies for ESG. Unlike Europe, the US lacks strict guidelines on what counts as a green bond and there are still questions about greenwashing. We are not yet at a point where we have good, strong principles guiding ESG investing. We’ll see how that develops over time. I think we’re nearing a tipping point as the conversation is there and people are coming together to reach a consensus on what can qualify. Investment managers are sourcing funds that have ESG policies and will need ESG investing – one way to do this is through auto finance. Even with green vehicles, there is still a lot to evaluate whether something should or does qualify according to ESG principles. Also, the SEC is increasingly focused on ESG-related disclosures. Initially, that focus was on mutual funds, but it’s expected to trickle down to ESG bonds as well.

Gripping: How does ABS compete with whole-loan sales as a form of financing for issuers?

Sarah: We have noticed that issuers are increasingly interested in selling whole loans. Some issuers have reduced the size of their ABS offerings to sell entire loans. I think that’s partly due to private funding and buyable investors. There are more investors and structures outside of plain vanilla 144A-term securitisations than in the past. It’s just that people have found other, more creative ways of doing things. There will always be 144A deals, but people will continue to innovate.

Gripping: Which trends do you think will continue in 2023 or new trends will emerge? Changes in deal structure in volatile market?

Sarah: We have seen floating reserve accounts to offset fluctuations in pricing and flexibility in other areas and structures to counteract volatility, and in turn increased over-collateralization requirements to absorb expected losses. There were a lot of stop and go’s in many trades just because the market was so volatile.

Gripping: Thanks for your time, Sarah. I am pleased to hear that your panel at ABS East was a success and the industry is excited to continue to evolve.

Sarah: Thank you, Griffin.

Leave a Comment