Article written by Annika Sandback, then VP/Senior Analyst at Moody's Investors Service (with assistance from Yan Yan), on the year's activity in the nonprime auto loan securitization market.
STRUCTURED FINANCE Speci al Report 2004 Revi ew and 2005 Outlook: Subpri me and Near-Pri me Auto Credi ts Shi fti ng Out of Neutral i nto Drive? AUTHORS: Annika Sandback Vice President Senior Analyst (212) 553-1482 Annika.Sandback @moodys.com Yan Yan Associate Analyst (212) 553-4083 [email protected]CONTACTS: Mil t on Chacon Managing Director (212) 553-7846 [email protected]Jay Eisbruck Managing Director (212) 553-4377 [email protected]Linda S t esney Managing Director (212) 553-3691 [email protected]Kumar Kan t han Senior Vice President (212) 553-1428 [email protected]Bre tt Hemmerling Investor Liaison (212) 553-4796 Brett.Hemmerling @moodys.com WEBSITE: www.moodys.com CONTENTS: • Opinion and Outlook • 2004 Review - Issuance Activity - Credit and Performance Trends - Recurring Theme: Is the Deep Subprime Market Underserved? • 2005 Outlook - Issuance Outlook - Credit Quality Outlook - Performance Outlook OPINION AND OUTLOOK Public and private issuance of subprime and near-prime automobile ABS is expected to increase by approximately 26%, or $4.9 billion, to reach $23.7 billion in 2005, based upon issuers' forecasts of loan originations growth in an improving economy. The credit quality of subprime and near-prime auto loan pools is expected to remain essentially unchanged in 2005 from that of pools securitized in 2004, as most issuers appear to have completed the tightening of under- writing that has taken place in the recent past. It remains to be seen, how- ever, whether, in the glow of an improving economy, issuers will begin to loosen their credit standards and originate loans of somewhat weaker credit quality than what we saw in 2003 and 2004. Moody's expects that the performance of pools that were securitized in 2003 and 2004 will continue strong through 2005. Performance of 2005 originations that are securitized should be strong so long as the appeal of loosening credit standards does not prove too alluring to issuers. In 2004, public issuance rated by Moody's declined by 7% to $17.2 billion from $18.5 billion in 2003. Total issuance, including private transactions, fell by a slightly higher percentage (9%) to $18.8 billion, as private transac- tion volume dropped by almost 24% year-over-year. The decline in total volume in 2004 marks a distinct departure from 2002's record $25.5 bil- January 13, 2005
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STRUCTURED FINANCE Special Report
2004 Review and 2005 Outlook: Subprime and Near-Prime Auto CreditsShifting Out of Neutral into Drive?
- Recurring Theme: Is the Deep Subprime Market Underserved?
• 2005 Outlook
- Issuance Outlook
- Credit Quality Outlook
- Performance Outlook
OPINION AND OUTLOOK
Public and private issuance of subprime and near-prime automobile ABSis expected to increase by approximately 26%, or $4.9 billion, to reach$23.7 billion in 2005, based upon issuers' forecasts of loan originationsgrowth in an improving economy.
The credit quality of subprime and near-prime auto loan pools is expectedto remain essentially unchanged in 2005 from that of pools securitized in2004, as most issuers appear to have completed the tightening of under-writing that has taken place in the recent past. It remains to be seen, how-ever, whether, in the glow of an improving economy, issuers will begin toloosen their credit standards and originate loans of somewhat weakercredit quality than what we saw in 2003 and 2004.
Moody's expects that the performance of pools that were securitized in2003 and 2004 will continue strong through 2005. Performance of 2005originations that are securitized should be strong so long as the appeal ofloosening credit standards does not prove too alluring to issuers.
In 2004, public issuance rated by Moody's declined by 7% to $17.2 billionfrom $18.5 billion in 2003. Total issuance, including private transactions,fell by a slightly higher percentage (9%) to $18.8 billion, as private transac-tion volume dropped by almost 24% year-over-year. The decline in totalvolume in 2004 marks a distinct departure from 2002's record $25.5 bil-
January 13, 2005
2004 Review and 2005 Outlook: Subprime and Near-Prime Auto Moody’s Investors Service • 2
lion and 2003's $20.6 billion (the second-highest year ever for the sector). Total volume in 2004 wasroughly equivalent to the levels seen back in 2000 and 2001. As was the case in 2003, during 2004most lenders continued to focus on credit quality at the expense of volume in response to a stronger, yetstill not robust, economic environment.
The primary driver of 2004's volume decline was large decreases in ABS issuance by several issuers,including Triad, Household and Onyx. Partially offsetting this was an increase in volume from issuerssuch as Capital One and Long Beach, and the relatively flat issuance volumes of a handful of other issu-ers. However, for the most part, the overall issuance decline was not due to decreases in origination vol-ume, but rather to transaction timing or the use by issuers of alternative financing sources.
The past year saw some modest changes in the competitive landscape. The major story was CapitalOne's purchase of Onyx, which is expected to close in the first quarter of 2005. In addition, CPS pur-chased SeaWest and subsequently ceased new loan originations under the SeaWest platform.
The credit performance of subprime and near-prime auto loan pools strengthened considerably in 2004.Due, in large part, to an improving macroeconomic climate, including a firming up of used car values,Moody's subprime auto credit indexes registered improving loss performance throughout 2004, as didmost individual issuers' pools securitized in 2003 and 2004.
The overall US macroeconomic picture looks fairly bright, with unemployment and personal bankruptciesfalling and interest rates expected to rise only modestly during the course of 2005. Given that thestrengthening in some of these macroeconomic indicators is still recent, however, subprime lenders maybe well advised to use caution before loosening credit standards in 2005 in order to gain volume.
2004 REVIEW
Issuance Activity
Issuance Drops by 9% in Second Consecutive Down YearTotal issuance of subprime and near-prime1 automobile ABS issuance rated by Moody's,2 including bothpublic and private transactions, fell 9% in 2004 from 2003's $20.6 billion to $18.8 billion. This reductionmarks the second consecutive down year in issuance since the sector endured a shakeout3 along withthe resulting volume reduction back in 1998. Volume in 2004 was roughly equivalent to levels seen in2000 and 2001. (See Figures 1 and 2.)
Major Issuers Continue to Dominate; Triad Drops Out of Top Six as Long Beach DebutsThe six major issuers that dominate the subprime and near-prime market segment changed complexionin 2004 as Triad fell out while Long Beach made its debut. (See Appendix 4 for the top six issuers bydollar volume rated by Moody's.) The primary driver of the volume decline in 2004 was large decreasesin ABS issuance by several issuers, which was somewhat offset by either increased or stable volumefrom others. However, for the most part, the overall issuance decline was not due to decreases in origi-nation volume, but rather to transaction timing or the use by issuers of alternative financing sources.
The top six issuers' share of 2004 volume was essentially unchanged from 2003 (at 80% versus 83%),considerably lower than the peak of 91% reached in 2002, but the top three issuers' dominanceincreased to 65%, a level not seen since 2000/2001. (See Figure 3.)
1 See Appendix 1 for a definition of the subprime and near-prime auto market categories.2 Since Moody's rates 100% of the transactions issued in the public market and a significant portion of the transactions issued in the
private market, the total volume of Moody's-rated transactions is a good proxy for total subprime and near-prime issuance. 3 The shakeout, which began in earnest in 1997 and remained in full force through 1998, has been described in previous Review/Out-
look publications for the sector.
2004 Review and 2005 Outlook: Subprime and Near-Prime Auto Moody’s Investors Service • 3
Two subprime auto lenders completed their first Moody's-rated term securitizations in 2004. In March,Wells Fargo Financial, Inc., a subsidiary of Wells Fargo & Company, executed its first transaction, at $470million, employing a senior/sub structure; and in September, United Auto Credit Corporation (UACC), asubsidiary of United PanAm Financial Corp., closed a $420 million wrapped transaction.
Figure 1Subprime and Near-Prime Automobile ABS Issuance
(Total Term Issuance Rated by Moody's)
Figure 2Subprime and Near-Prime Automobile ABS Issuance
(Total Term Issuance Rated by Moody's: Public vs. Nonpublic)
2004 Review and 2005 Outlook: Subprime and Near-Prime Auto Moody’s Investors Service • 4
Credit and Performance Trends
Pool Performance ImprovesAfter weak performance for most of 2001 through 2003, Moody's Static Chargeoff Indexes4 began toshow signs of performance stabilization in the last two months of 2003. In the first quarter of 2004,subprime auto loan pools began to show sustained signs of performance improvement. This continuedthroughout the year. In fact, according to a new index measure added to Moody's Subprime AutoIndexes in the second quarter of 2004, the annualized net loss rates for the high-loss, low-loss and all-pools categories declined for the third quarter in a row, and were 26% to 50% lower than a year earlier.In the third quarter of 2004, the annualized net loss rates for all categories declined between 19% and46% compared with the same quarter in 2003.
The latest performance trends as gauged by the index values seem to indicate that the improving USeconomy has positively impacted the performance of subprime auto loans in terms of frequency of loss.Performance has also been aided by the recent stabilization of used car values, which has helped toreduce severity of loss.
A recent analysis conducted at the deal vintage level5 by Moody's for the top six major issuers revealsthat, while many issuers' 2000 through 2002 vintages have shown relatively weak performance relativeto their 1999 vintages (with some having reached or exceeded the loss levels of their historically worst-performing 1997 vintages), the 2003 and 2004 vintages of most of the top six are showing a great dealof improvement (see Figures 4 to 9).
Figure 3Subprime and Near-Prime Automobile ABS Issuance
(Top Issuers as % of Total Issuance)
4 See Moody's monthly and quarterly Subprime Auto Loan Credit Indexes. For a detailed explanation of the construction of the indexes, see "Gauging Subprime Auto Loan Transactions: Moody's Unveils New Credit Indexes," Moody's Structured Finance, June 13, 1997.
5 The vintage analysis was conducted at the issuer level by taking a straight (i.e., unweighted) average of the cumulative net loss per-formance for each issuer's deals that closed in a given year. For example, the performance of each of an issuer's individual deals that closed in 2000 was averaged to form the issuer's 2000 vintage performance.
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2004 Review and 2005 Outlook: Subprime and Near-Prime Auto Moody’s Investors Service • 5
Figure 4WFS Deals - Vintage Analysis
Figure 5AmeriCredit Deals - Vintage Analysis
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2004 Review and 2005 Outlook: Subprime and Near-Prime Auto Moody’s Investors Service • 6
2004 Review and 2005 Outlook: Subprime and Near-Prime Auto Moody’s Investors Service • 7
Stock Prices Fare Well, but Pale in Comparison to 2003's ReboundAfter several years of disappointing share performance, the stock prices of most public companies in thesubprime auto finance sector increased sharply in 2003. This rebound was primarily a reflection of howlow stock prices had previously fallen. In 2004, stock prices fared well, but in terms of year-over-yearcomparisons, did not perform nearly as well as in 2003. Among the standouts in 2004 were Onyx andWFS, both of which saw their stocks surpass their previous all-time highs during the course of 2004.Both Credit Acceptance and United PanAm also ended the year close to their all-time highs.
Figure 8Long Beach - Vintage Analysis
Figure 9Household Deals - Vintage Analysis
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2004 Review and 2005 Outlook: Subprime and Near-Prime Auto Moody’s Investors Service • 8
The smaller percentage increases in 2004 relative to the 2003 increases (with the exception of Onyx) stilloutpaced the overall market, which ended the year at a level only moderately higher than at the year'soutset. This appears to be an indication of the equity market's belief that the industry's prospects for2005 continue to be positive.
Rating Actions: 8 Tranches Upgraded, None DowngradedIn 2004, seven tranches of four AmeriCredit senior/sub transactions were upgraded (one tranche wasupgraded twice), as was one tranche of a WFS transaction. (See Appendix 5 for details.) The upgradesreflect a strengthening in the credit profile of the upgraded securities, based upon a build-up of creditenhancement relative to expected future losses in the underlying receivables pools.
Otherwise it was a quiet year, with no downgrades and no transactions placed on review for possibledowngrade in 2004.
Recurring Theme: Is the Deep Subprime Market Underserved?A refrain heard often in the recent past from some subprime market players is that the "deep" segment oftheir market has become underserved. This segment is typically thought to comprise borrowers with theweakest credit quality. Loans to these borrowers both experience the highest loss rates but also oftenproduce the highest returns. Beginning in the late 2001 to 2002 timeframe and continuing through theearly part of 2004, most subprime auto lenders were faced with the highly unusual "double whammy" ofincreased frequency of loss due to weak macroeconomic conditions and higher severity of loss due to aweak used car market. The strategy employed by many of these lenders in the face of these marketconditions was to tighten credit guidelines and move up-market within the subprime space in order toslow the pace of losses.
As the bigger players move out, there are smaller, niche players who perhaps can fill the deep subprimemarket space, if in fact it is currently underserved. However, the question remains as to whether thosewho pulled back from the deep subprime market segment in times of economic weakness, uncertainty,or even gradual improvement, will continue to hold the reins as tightly if the economy improves further in2005 and the used car market remains stable. If loans are priced correctly for the inherent risk, this maybe a tempting strategy. And if it occurs, even if only incrementally, we may well see somewhat weakerpools securing some subprime securitizations, which would inevitably lead to weaker performance.
Figure 10Stock Price History of Subprime and Near-Prime Auto Finance Companies
2004 Review and 2005 Outlook: Subprime and Near-Prime Auto Moody’s Investors Service • 9
2005 OUTLOOK
Issuance Outlook Public and private issuance of subprime and near-prime automobile ABS is expected to increase byapproximately 26%, or $4.9 billion, to reach $23.7 billion in 2005. This figure is based on issuers' ownforecasts of loan originations growth, which they believe will be driven by relatively strong macroeco-nomic conditions in the coming year as well as transaction timing.
Credit Quality OutlookThe credit quality of subprime and near-prime auto loan pools originated in 2005 is expected to remainessentially unchanged from that of pools securitized in 2004, as most issuers appear to have completedthe tightening of underwriting standards that took place in the recent past. It still remains to be seenwhether, in the glow of an improving economy, issuers will begin to loosen their credit standards andoriginate loans of somewhat weaker credit quality than what we saw in 2003 and 2004. Key factorsinforming Moody's outlook on credit quality include the following:
• Unemployment is falling: The US unemployment rate fell during the course of 2004 from an average of 6.0% in 2003 to5.4% in November 2004. According to Moody's Chief Economist, John Lonski6, even if the USeconomy were to slow somewhat in 2005, as is expected, the annual growth rate of real GDPshould still be sufficient to lower November's 5.4% unemployment rate to 5.1% by year-end 2005.Profits are likely to increase sufficiently in 2005 to widen profit margins and extend a corporatecycle upturn, which should boost payrolls. The unemployment rate will be watched closely, as akey driver of defaults on subprime auto loans is a shock to household liquidity, which often can bethe result of job loss.
• Interest rates are not expected to rise precipitously: As the most significant consequence of rising interest rates is the impact on the consumer debtburden and consequent consumer default likelihood, the predicted environment in 2005 of onlymodestly higher long-term interest rates is good news, relatively speaking, for consumer lenders.
• Personal bankruptcy filings are falling:As of the third quarter of 2004, the rate of personal bankruptcy filings had fallen meaningfully fromthe high levels of 2002 through the first half of 2003. In the second half of 2003, there were signsof stabilization followed by improvement. As of the third quarter of 2004, there had been four con-secutive quarters of year-over-year decreases in personal bankruptcy filings. (See Figure 11.)
6 Source: Chief Economist John Lonski's commentary in the December 6, 13 and 20 issues of "Credit Trends Weekly Commentary," Moody's Investors Service Global Credit Research.
2004 Review and 2005 Outlook: Subprime and Near-Prime Auto Moody’s Investors Service • 10
Given the relatively recent strengthening in some of these macroeconomic indicators, however, subprimelenders may be well advised to use caution before loosening their credit standards in 2005 in order togain volume.
Performance OutlookThe performance of pools that were securitized in 2003 and 2004 is expected to stay strong in 2005.Performance of 2005 originations that are securitized should be strong so long as the appeal of loosen-ing credit standards does not prove too alluring to issuers.
Aiding pool performance should be a lower frequency of loss as a result of the improved economic con-ditions described above. In addition, Moody's expects that severity of loss will remain stable as a func-tion of a stable used car market.
Chart 11Non-Business Bankruptcy Filings per Quarter
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2004 Review and 2005 Outlook: Subprime and Near-Prime Auto Moody’s Investors Service • 11
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APPENDIX 1Moody's Definition of the Subprime Auto Market
UnderwritingCredit Category
Implied Credit Grade
Static Pool Losses (%) Discounts (%)
Bankruptcy Tolerance
Length of Clean1 Credit
Prime A+ to B <3 None None > 5 yrsNear-Prime B- to C+ 3-7 None >2 yrs Discharged 2-5 yrsSubprime C to C- 7-15 <10 1-2 yrs Discharged 1-2 yrs
D+ to D- 15-25 10-30 < 1 yr Discharged < 1 yr"EZ” E to Z 25-50 30-50 Irrelevant None1 "Clean" credit is a relative term, and its meaning changes depending on the credit category.
APPENDIX 2Moody's Current Classification of Active Issuers7 by Credit CategoryNear-Prime Sub-Prime8
Franklin Capital AmeriCreditLong Beach9 Capital One Auto Finance10
Onyx CPS WFS Credit Acceptance
Drive FinancialDriveTimeHousehold Auto FinancePrestigeTriadUnited Pan AmWells Fargo Financial
7 Active issuers, for the purpose of this table, are defined as those that have issued auto ABS rated by Moody's in 2004 and are still originating auto loans.
8 For simplicity's sake, the EZ credit category has been rolled into the subprime category.9 Long Beach has been reclassified into the near-prime category, consistent with the expected performance of its most recent trans-
actions. Earlier transactions have exhibited a level of credit losses consistent with subprime pools.10 Capital One also originates prime auto loans, which are securitized separately from their nonprime originations.
APPENDIX 3Historical Number and Dollar VolumeSubprime and Near-Prime Auto Deals Rated by Moody's
APPENDIX 52004 Rating Actions Taken onSubprime and Near-Prime Auto Deals Rated by Moody's
Transaction Tranche Rating Action DateAmeriCredit Automobile Receivables Trust 2000-1 Class B Upgraded from Aa3 to Aaa 2/24/04AmeriCredit Automobile Receivables Trust 2000-1 Class C Upgraded from A3 to Aa3 2/24/04AmeriCredit Automobile Receivables Trust 2001-1 Class B Upgraded from Aa3 to Aa2 2/24/04AmeriCredit Automobile Receivables Trust 2001-1 Class B Upgraded from Aa2 to Aaa 12/22/04AmeriCredit Automobile Receivables Trust 2001-1 Class C Upgraded from A3 to Aa1 12/22/04AmeriCredit Automobile Receivables Trust 2001-1 Class D Upgraded from Baa3 to Baa2 12/22/04AmeriCredit Automobile Receivables Trust 2002-1 Class B Upgraded from Aa3 to Aa2 12/22/04AmeriCredit Canada Automobile Receivables Co-Ownership Certificates, Series 2002-A
Class B Upgraded from A2 to Aa2 12/22/04
WFS Financial 2003-2 Owner Trust Class D Upgraded from Baa2 to Baa1 12/22/04
2004 Review and 2005 Outlook: Subprime and Near-Prime Auto Moody’s Investors Service • 13
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2004 Review and 2005 Outlook: Subprime and Near-Prime Auto Moody’s Investors Service • 15
MOODY’S hereby discloses that most issuers of debt securities (including corporate and municipal bonds, debentures, notes and commercial paper) and preferred stock rated by MOODY’S have,prior to assignment of any rating, agreed to pay to MOODY’S for appraisal and rating services rendered by it fees ranging from $1,500 to $2,400,000. Moody’s Corporation (MCO) and its wholly-
2004 Review and 2005 Outlook: Subprime and Near-Prime Auto Moody’s Investors Service • 16
