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ABS Spotlight Summary - April 2017

Core Content Overview

This edition of ABS Spotlight provides an in-depth analysis of credit implications in the US and Canadian asset-backed securities (ABS) markets, focusing on e-contracts, auto finance, credit cards, and utility securitizations.

Main Topics and Key Insights

1. E-Contract Exposure in ABS Collateral

• Credit Impact: The use of electronic contracts ("e-contracts") in ABS collateral is generally credit neutral if issuers ensure that investors have senior claims to cash flows.
• Legal Perfection: E-contracts require different legal perfection methods compared to physical contracts. For secured e-contracts (e.g., auto, equipment), issuers must ensure control over the contracts. For unsecured e-contracts (e.g., marketplace lending, student loans), a UCC financing statement is sufficient.
• Efficiency Gains: E-contracts improve loan origination efficiency for both borrowers and lenders. For example, Deleartrak reported a 20% increase in dealers signing up for e-contracting platforms from 2015 to 2016.
• Market Trends: Auto, marketplace lending, and student loan refinancing ABS have already included e-contracts, while other sectors are exploring their inclusion.

2. Auto Finance: Credit Risk Increases with Negative Equity

• Sales Plateau: New vehicle sales have plateaued since 2010, leading to increased competition and looser lending terms.
• Negative Equity: The percentage of trade-ins with negative equity reached an all-time high, with the average negative equity amount also rising.
• Trade-in Treadmill: This trend leads to higher loan-to-value ratios, slower amortization, and higher loss severity when defaults occur.
• Manufacturer Response: If manufacturers increase incentives or cash rebates, this could weaken their profitability and affect used car values.
• Credit Card ABS Impact: The US Prime Auto Loan ABS credit indices showed a net loss rate of 0.86% in February 2017, up from 0.73% in February 2016. The delinquency rate also increased to 0.58% from 0.48% year-over-year.

3. Santander Consumer USA's Credit Negative Impact from Settlements

• Settlements: SC USA settled predatory lending allegations in Massachusetts and Delaware for $26 million.
• Credit Costs: The settlements increase credit costs and expose the company to additional legal expenses.
• Default Rates: 42% of subprime auto loans from high-risk dealers in these states have defaulted or will default, significantly higher than the overall portfolio.
• Securitization Impact: The settlements are credit negative for SC USA's securitizations, as they indicate inflated income and collateral values used in underwriting.
• Future Implications: SC USA does not intend to repurchase affected loans, and indirect loans from 2014 or earlier are more vulnerable to default.

4. Credit Card ABS Performance

• US Charge-offs: The US Card Charge-offs slightly increased to 2.60% in February 2017 from 2.56% in January.
• Delinquency Rates: The delinquency rate rose to 1.52%, up from 1.51% in January, and increased 6 bps year-over-year.
• Payment Rate: The payment rate fell to 24.55%, down 212 bps from January, but remains exceptionally high compared to long-term averages.
• Yield and Excess Spread: Yield improved to 18.63%, while excess spread increased to 13.08%.
• Canadian Performance: The Canadian Credit Card Charge-offs declined to 3.19% in February, down 34 bps from February 2016. Payment rate dropped to 37.19%, but is expected to remain strong due to the high proportion of convenience card users.

5. Utility Cost Recovery Charge Securitizations

• True-up Mechanism: The true-up mechanism helps mitigate volatility in electrical consumption by allowing servicers to increase utility fees to ensure timely bond payments.
• Capital Subaccount Deficits: Three UCRC transactions had capital subaccount deficits as of January 2017, which are expected to be replenished through true-ups.
• Weather Impact: Unseasonably warm weather led to unexpected decreases in electricity usage, resulting in capital subaccount deficits for some deals.
• Past Performance: Servicers have successfully managed deficits in the past, such as MP Environmental Funding LLC and TE Funding LLC, which were corrected in 2013 and 2015.

Summary of Key Credit Indices

Sector Updates and Rating Actions

• Auto ABS: 23 upgrades and 3 downgrades in March 2017.
• Credit Card ABS: 0 upgrades and 0 downgrades.
• Student Loan ABS: 31 upgrades and 277 downgrades.
• Equipment ABS: 13 upgrades and 59 downgrades.
• Other ABS: 1 upgrade and 59 downgrades.

Conclusion

This issue highlights the evolving credit dynamics in the US and Canadian ABS markets, with particular focus on the impact of e-contracts, increased credit risk in auto finance, negative equity trends, and the role of true-up mechanisms in utility securitizations. While some areas show credit neutrality or improvement, others, like Santander Consumer USA and the auto sector, face credit negative implications due to legal settlements and market conditions. The performance of credit indices suggests ongoing challenges for some sectors, but improved risk management and legal compliance are expected to support future stability.