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As Crisis Fades, Risk Returns to Asset-Backed Debt

reuters.comMar 16, 2012

As the credit crisis recedes and underwriting standards begin to loosen, bonds backed by consumer debt such as auto loans, credit card payments, and student loans are becoming increasingly risky, Moody's said on Thursday.

Relaxed underwriting standards, more complex structures, and new untested market participants are just three of the trends suggesting that risk is on the rise for some sectors of the asset-backed securities market, Moody's said in a report.

Even in the residential mortgage sector, which has not seen a significant return of private-label securitization, riskier non-prime, non-traditional mortgage originations are appearing.

With credit standards slipping in asset classes such as subprime auto loans, and risky crisis-era structural features showing up in transactions, credit rating agencies need to make sure they are keeping up with the deteriorating credit standards and rating the these bonds appropriately -- which means withholding their coveted Triple A rating if it is not deserved, or making sure there are other features that mitigate the risks, said Moody's.

Some of Moody's competitors have recently given Triple A ratings to ABS transactions that, in its view, did not deserve the top grades, particularly in the subprime auto space.

"We want to make sure that the credit protections that investors have keep pace with the evolution of the market," said Claire Robinson, the head of new-issue structured finance ratings at Moody's and author of the report.

"There's a natural evolution in the credit cycle, and after the huge credit crunch came about as part of the crisis, we are now seeing the beginnings of credit loosening, which is normal. But as underwriting loosens, we need to make sure we're keeping an eye on investor protections in these deals.

"Non-traditional issuers and/or collateral are successfully coming to market again, indicating that investors have more of an appetite for risk."

AAA NOT DESERVED ON SOME DEALS

The riskiness of securitizations is still low and has not approached the level it reached in the early to mid-2000s, Robinson said, much less the level it reached at the height of what is now generally considered the credit bubble in 2006 and 2007.

ABS reached its issuance peak in 2006 at $754 billion.

However, if the normal pattern of the credit cycle plays out, the easing of credit that took place in 2011 will persist into 2012 and beyond, she said.

Originators have begun to ease underwriting standards, which is a natural progression from the extremely tight credit conditions that followed the onset of the financial crisis. However, in sectors such as subprime auto-loan securitizations, where underwriting is returning to its pre-recession norm, losses on loan pools backing auto ABS are bound to increase.

Issuers can compensate for this risk with the proper level of so-called credit enhancement, or the buffer protecting investors in the most senior bonds. Sometimes structural enhancements help mitigate the risk as well.

However, Moody's would not have assigned Triple A ratings to certain recent transactions that it did not rate, including a subprime auto deal issued by Exeter Finance Corp, which received high investment-grade ratings from Standard & Poor's and DBRS.

Even those two rating agencies disagreed on the top slice of the transaction: S&P assigned it a AA rating while DBRS awarded it a AAA. The US$200m deal priced on February 23.

"Exeter is small and unrated, with limited experience and little asset performance history," Moody's said. "The resulting potential for volatility in asset performance makes high invest-grade ratings inappropriate."

Subprime auto securitization has been increasing recently. This week alone, asset-backed backed offerings from Santander Consumer USA and Consumer Portfolio Services (CPS) were increased in size due to investor demand and oversubscribed, meaning that the demand for the bond exceeded the amount of issuance available several time over.

Similarly, in the credit card sector, Moody's said that the senior classes of bonds sponsored by issuers such as Cabela's, World Financial Network, CompuCredit and 1st Financial do not merit Aaa Moody's rating because of the weaker credit profile of the sponsors and the risk that they may not service the debt appropriately.

Moody's also noted that the volume of mailings in 2011 soliciting credit card customers was about double the level of 2010, with an increased emphasis on offerings to individuals with less than pristine credit histories.

Although credit standards are still tighter now than they were before the recession, the newest credit card vintages have more lower-quality accounts than do vintages originated in late 2009 and early 2010.

Moody's also raised a red flag about the entrance of private equity funds, hedge funds, and investment banks into the subprime auto and mortgage businesses.

"A sign that asset credit quality will continue to loosen in the subprime auto and mortgage sectors is the influx of non-traditional private capital into mostly subprime consumer lenders that will tap the securitization market," Robinson wrote.

For example, Moody's says that Pimco is considering buying a stake in subprime auto lender CPS, while Blackstone (BX.N) is interested in Exeter Finance and Perella Weinberg has set its sights on CarFinance Capital/Flagship Credit.

In the mortgage market, Fortress purchased subprime lender American General (now, Springleaf) from AIG in late 2010, and Shellpoint Partners acquired New Penn Financial. BlackRock recently announced that it had more than doubled its investment in PennyMac, a mortgage REIT.

"The entrance of players ... with higher risk profiles is a sign that competition for asset origination will increase," Robinson said.

Moody's also noted that certain risky structural features, such as "prefunding accounts", or cash reserve funds for the purchase of assets after a transaction's close, have begun returning to ABS deals for the first time since the onset of the crisis. The risk there is that the assets purchases after the transactions closes may be of lower quality than what investors were expecting.

Additionally, small originators and issuers with low credit quality have been getting back into the game, and their ability to honor representations and warranties may be limited.

Moody's warning comes during the busiest week of ABS issuance so far this year.

More than US$7.5bn in asset-backed volume across 11 deals is expected to price by Friday.

The surge of issuance brings year-to-date volume to more than US$45bn, putting it significantly ahead of 2011 issuance at the same point last year, which was roughly US$30bn. The encouraging level of issuance also puts ABS volume on a trajectory to eclipse last year's US$125bn full-year total.

At least four deals this week were upsized due to investor demand and oversubscribed.

Moreover, there were very large bid lists and increased trading in the secondary markets, as the buyside started rolling off seasoned paper in order to be able to allocate the money to the swath of deals in the primary. More than US$1.5bn traded in the non-mortgage ABS secondary so far this week, while a typical week usually sees US$500m trading.

Investors have money to put to work, dealers say, and the positive momentum in broader economic activity -- both consumer and commercial -- may have encouraged issuers to opportunistically tap the market.

On the other hand, the sheer range of asset classes represented this week -- auto lease, subprime auto, timeshare receivables, structured settlement, equipment, UK credit card, UK RMBS with US dollar tranches -- suggests that the trend may go beyond just opportunistic issuance, and that the ABS market may actually be poised for strong year-over-year growth for the first time since the crisis.


Back to March 2012 Archive

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