Ratings agencies and other players in the finance world are beginning to sound the alarm on auto backed securities. Among the most troubling factors for some investors is the growth of smaller issuers who rely on pools of deep subprime loans. And ratings agencies who are being more conservative with their ratings are missing out on the action.
A report by Reuters highlights a recent ABS offering from Security National Automotive Acceptance Co (SNAAC), a smaller firm that focusing on loans to military personnel. This offering received a solid rating despite seemingly poor fundamentals.
According to the S&P, around 24% have ultra-low FICOs of between 500 and 550. And roughly 24% of the loans have loan-to-value ratios of 115% to 120% – meaning that the borrowers owe more than their vehicles are worth. Even so, S&P rated the deal AA, while rival DBRS gave it a full AAA rating.
Some players in the fixed income industry say that this kind of practice is far from an isolated incident. Ostensibly, a boom in subprime ABS has led to new players who are hungry for loans, regardless of quality
“The gap between the biggest players and the smaller issuers is just massive,” said John Kerschner, the head of securitized-product investing at Janus Capital Group. The smaller second-tier players go to deep, deep subprime – in the range of a 500 FICO score. That may not be the person you want to lend money to.”
Even more troubling is an assertion that ratings agencies Moody’s and Fitch, two well known companies in the bond ratings world have been deemed too cautious by a number of issuers, and thus have not been hired to rate their deals. Needless to say, this effectively stifles any outlooks that are less than rosy. John Bella, a top ABS official at Fitch, told Reuters
“We are generally more reluctant to reach AAA on subprime auto ABS for numerous reasons, among them the sector’s innately more volatile performance history, operational concerns and often heavy reliance on securitization as sole source of funding. Stiffer competition and deteriorating underwriting in recent months are amplifying our concerns.”
While the Reuters piece questions how investors may fare in the event of a burst ABS bubble, TTAC has long maintained that the real risk lies with new cars, the auto makers, and another possible systemic crisis. Auto manufacturers could interpret rising sales in an overly optimistic fashion, and start adding capacity as a result. But if the growth in sales is being driven by subprime lending, then it is inherently vulnerable to a slowing economy or an increase in unemployment. Either of those factors could be the trigger that causes subprime buyers to start defaulting. Used cars are less affected by this problem. They can simply be pumped through the system again and again, and the nature of subprime lending itself means that (if executed correctly) the high interest paid by everyone else can offset the losses brought on be delinquent debtors. If new car sales were to experience a significant contraction due to external forces like these, then auto makers could be left with a 2008-style scenario of idle plants, excess capacity and a glut of inventory, all of which are enormously costly to the OEMs.