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Spread compression shows 'everybody likes subprime auto'

It turns out that the fourth quarter of 2017 might not be as good as it gets for the execution of securitizations backed by subprime auto loans.

Lenders have continued to find strong investor demand in the first two months of 2018, and the coupons have been especially favorable considering that they have been achieved against the backdrop of a rising interest rate environment.

When asked during a Feb. 20 conference call about competition in the subprime space, America's Car-Mart Inc. President and CEO Jeffrey Williams said that there is "still quite a bit of money out there."

"The interest rates on securitizations are lower than they were a year and a half ago even though rates have gone up," he added.

Another subprime lender, Consumer Portfolio Services Inc., has experienced that phenomenon first hand. The weighted average coupon on its first securitization of the 2018 vintage in January, the $190 million CPS Auto Receivables Trust 2018-A, was 3.46%. That was 45 basis points tighter than a comparably sized transaction in January 2017, though it was slightly wider than the company's final 2017 transaction.

Spreads widened on the AAA and AA tranches of the latest deal relative to that January 2017 transaction, but they narrowed considerably for the more subordinated classes, including by 103 basis points on the junior-most notes. The Federal Open Market Committee raised its target for the federal funds rate on three separate occasions during that 12-month time frame.

"We probably had the best execution on securitizations that we've had maybe in the history of the company," Consumer Portfolio Services Chairman, President and CEO Charles Bradley said during a Feb. 15 call.

Strong demand has persisted even as supply has risen.

Auto-related U.S. ABS issuance totaled $14.69 billion in January, according to data reported by the Securities Industry and Financial Markets Association. That marked an increase from $8.87 billion in the year-earlier month. U.S. auto-related ABS issuance topped $10 billion in three of the 12 months in 2017, topping out at $12.61 billion in October 2017.

Multiple subprime auto ABS deals are among the transactions that closed during January, including a $1 billion Westlake Services LLC-sponsored transaction. Rating agencies have issued presale reports for several additional subprime auto deals to date in February, highlighted by a $938 million deal on Santander Consumer USA Holdings Inc.'s Drive Auto Receivables Trust deep subprime platform, a $266.5 million transaction sponsored by BlueMountain Capital Management LLC's Global Lending Services LLC and a $200 million deal from Perella Weinberg Partners Asset Based Value Strategy's Flagship Credit Acceptance LLC.

"All that money out there [is] looking for a place to go, and everybody likes subprime auto," Bradley said.

"The fact that Wall Street and the capital markets really like the paper and are willing to pay up for it and we're having oversubscription on all tiers of our bonds it's getting to be a really good thing, and we would expect and hope it to continue," he added.

The outlook for auto ABS performance overall remains mixed. In a recent report, S&P Global Ratings cautioned that it expects that recovery rates for prime and subprime auto ABS, alike, will continue to weaken in the near term and lead to higher net losses for securitization due to the effects of softer used vehicle values and the increasing amounts of loans with higher loan-to-value ratios and longer original terms in collateral pool.

But despite the rating agency's expectations of higher losses and less-robust recovery rates, it believes ratings will stay stable. S&P did warn, however, that its non-investment-grade ratings are "more sensitive" to worsening credit conditions.

The conventional wisdom around the industry has been that favorable securitization market conditions have helped forestall consolidation of the various subprime lenders, a number of which are backed at least in part by private equity funds.

"So some of our friendly competitors who are having trouble in the market, if you can keep that lower cost [of] funds, that probably gives them a little more runway to get things turned around and fixed," Consumer Portfolio Services' Bradley said.

Both he and America's Car-Mart's Williams also expressed hope that federal tax reform will be beneficial for their respective companies' customer bases in 2018.

"Just the face of it," Bradley said, "any kind of tax cuts benefits our folks probably more than anyone else because they probably are very tight on disposable income."

S&P Global Ratings and S&P Global Market Intelligence are owned by S&P Global Inc.