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Larger loans to mitigate impact of slowing car sales on ABS market

An expected decline in the seasonally adjusted annualized rate of light vehicle sales in 2020 may not preclude another strong year for auto loan originations and, in turn, securitization volumes.

S&P Global Ratings projects in its "Global Structured Finance Outlook 2020" report that full-year U.S. auto ABS issuance will hold relatively steady, near the levels achieved by the market in both 2018 and 2019.

The projected range of issuance of between $80 billion and $82 billion compares with issuance volumes of $81.7 billion in 2018 and $82.1 billion in 2019. Included within that outlook, S&P Global Ratings expects consistent levels of subprime auto ABS issuance in a range from $29 billion to $30 billion in 2020.

The report noted that the slight increase in 2019 issuance occurred despite a modest decline in estimated U.S. light-vehicle sales. Shifting consumer preferences toward larger, more expensive vehicles such as trucks, sports utility vehicles and crossover vehicles have resulted in higher average transaction prices and, in turn, larger loan balances, the rating agency said. And as Stephen Steinour, chairman, president and CEO of Huntington Bancshares Inc., pointed out during a December 2019 appearance at an investor conference, "auto sales are very good by historical standards." Huntington is a regional bank with a significant auto finance operation.

Leading auto ABS issuers in 2019 as disclosed by S&P Global Ratings included the likes of specialty finance companies such as Santander Consumer USA Holdings Inc., captive auto lenders Toyota Motor Credit Corp., General Motors Financial Co. Inc., American Honda Finance Corp. and Ford Motor Credit Co. LLC, and the finance arm of used vehicle retailer CarMax Inc. Several of those companies, including Santander Consumer, GM Financial and CarMax, have already filed documentation with the SEC in the opening days of 2020 associated with their inaugural transactions of the new year.

Statistics contained in a recent report from the New York Fed Consumer Credit Panel and Equifax supports the notion that loan balances are rising even as the annualized rate of vehicle sales slows to a certain extent. The data show that U.S. auto loan originations increased by nearly 1% in the third quarter of 2019 to $159.1 billion, a level that is second only to the third quarter of 2005 as the strongest on record. By credit tier, origination growth rates were strongest among borrowers with Equifax Risk Scores of 720 and above. Loans to borrowers with scores of less than 620, a level that generally is regarded as subprime, accounted for 18.9% of third-quarter 2019 originations. The median Risk Score at origination for the period as 711, the highest level in nine years.

The New York Fed interpreted that increase as an indication of a tightening in underwriting standards, though certain lenders have not drawn quite the same conclusions from their market observations.

CarMax Executive Vice President of Finance Thomas Reedy said during a December 2019 earnings conference call that the company's auto finance arm has seen "no need to adjust" its credit appetite.

Capital One Financial Corp. Chairman, President and CEO Richard Fairbank observed anecdotally during his December 2019 appearance an investor conference that competition in the auto finance space is "pretty rational," though he described market conditions as "good but not great."

S&P Global Ratings expects an "influx" of late-model vehicles coming off lease in 2020 to drive a decline of between 3% and 5% in used-vehicle values, a metric that represents a key indicator of recovery rates on repossessions. The report noted that used-vehicle values "held up surprisingly well" in 2019 even as off-lease vehicle volumes reached a record high during the year.

Fairbank has regularly remarked about the resilience of the used-vehicle market, including during the recent investor conference.

"This industry has been buoyed by used car pricing that is high and has consistently, over the years, been higher than our own expectations," he said. "And I think we are all wise to underwrite and possibly invest with an expectation that that thing is coming down." That sort of underwriting discipline may be difficult to maintain across the entire auto finance industry, he conceded, given the track record of "years of high auction prices" in the used-vehicle market.

S&P Global Ratings said that auto loan ABS recovery rates have been "holding up well," though it cautioned that high levels of manufacturer incentives in late 2019 served as an "ominous" sign.

"If manufacturers grow dependent upon these for a prolonged period," the rating agency said, "recovery rates could skid going forward."

This S&P Global Market Intelligence news article may contain information about credit ratings issued by S&P Global Ratings. Descriptions in this news article were not prepared by S&P Global Ratings.