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ABS Spotlight Summary - October 2016

Core Content

The October 2016 edition of ABS Spotlight focuses on the impact of regulatory changes and market dynamics on the asset-backed securities (ABS) industry, particularly in the automotive, credit card, and student loan sectors. It also highlights the broader implications of the Takata airbag recall and the evolving credit risk landscape due to the global shift toward carbon reduction.

Main Views and Key Information

Regulatory Challenges and Market Adaptation

• Regulatory Headwinds: Attendees at ABS East 2016 expressed that regulatory challenges, such as risk-retention requirements and loan-level disclosure rules, are manageable but will affect transaction costs, volumes, and issuer types.
• Risk-Retention Rules: These rules, set to take effect on 24 December 2016, are prompting issuers in various sectors (e.g., auto, student loans, marketplace lending) to evaluate their compliance strategies and consider alternative options.
• CLO Market: Fewer managers are expected to participate in the CLO market, but the number is likely to remain stable. The rules are seen as allowing flexibility in risk-retention approaches, depending on the business model of each manager.
• Secondary Market Liquidity: New regulations, such as the Financial Industry Regulatory Authority's (FINRA) trade reporting requirements, are viewed as constraining secondary market liquidity, though some see transparency as a benefit.
• Margin Requirements: Changes in margin requirements for over-the-counter derivatives may influence the use of swaps in securitizations.
• Fair Lending Rules: Concerns exist about how fair lending rules might affect marketplace lenders.

Takata Airbag Recall Impact

• Auto Lease ABS: The recall of Takata airbags has a significant negative impact on auto lease ABS, especially for transactions involving Volkswagen, BMW, and World Omni. Delays in replacement parts lead to higher residual value losses.
• Auto Loan and Floorplan ABS: These are less affected due to minimal exposure to recalled vehicles and the fact that recalls have not historically been a defense against loan repayment.
• Volkswagen Auto Lease Trust (VALT) 2015-A: This transaction has experienced high residual value losses (36% in July, 19% in August) due to Takata airbag issues and non-compliant diesel engines. VW Credit, Inc. added $72 million to the reserve fund to mitigate these losses.
• BMWLT 2015-1 and World Omni 2014-A: These transactions have seen only marginal deterioration in performance, attributed more to the used car market decline than the Takata recall.

Automotive Industry Outlook

• Global Automotive Manufacturing Outlook: Moody's has moved the outlook to negative for the global automotive manufacturing industry, citing softening demand in key markets like the US and China.
• US Market: Sales are expected to rise slightly in 2016 and decline modestly in 2017 due to plateauing demand and slowing growth.
• Western Europe: Sales are expected to contract in 2017 after a strong 2016 growth, with manufacturers facing pricing pressure and margin erosion.
• China: Sales growth is projected to slow from 6.7% in 2016 to 2.7% in 2017. A potential extension of the tax cut for small engines could help boost growth.
• Japan: Sales are expected to fall in 2016 and grow only slightly in 2017, impacted by weak domestic demand, delayed tax increases, and a strong yen against the dollar.

Credit Card and Student Loan ABS

• US Credit Card Index: Charge-offs and delinquencies increased in August 2016, indicating a rise in credit risk for credit card ABS.
• Private Student Loan ABS: Moody's noted that the outlook for private student loan ABS is stable, returning to pre-recession levels. The recent usury law ruling was viewed as credit positive for some segments.

Emerging and Re-emerging ABS Sectors

• Mobile Phone Financing: Interest is growing in securitizing loans and leases used to purchase mobile phones, due to their granular nature and consumer ties.
• Marketplace Lending: The sector is recovering from earlier challenges but still faces legal, data quality, and alignment risks.
• Non-Prime Mortgages: Originations are slowing but still strong enough to support securitization activity.
• Reverse Mortgages, PACE, and Solar Financing: These are seen as potential new or re-emerging securitization sectors.

Key Sectors and Their Credit Implications

Auto ABS

• Lease ABS: Higher risk of loss due to Takata airbag recall.
• Loan and Floorplan ABS: Minimal impact due to limited exposure and historical loan repayment resilience.

Credit Card ABS

• Rising Delinquencies: Charge-offs and delinquencies increased in August 2016, signaling heightened credit risk.

Student Loan ABS

• Stable Performance: Private student loan ABS indices have stabilized at pre-recession levels.
• Legal Rulings: A recent usury law ruling was viewed as credit positive for some private student loan and marketplace lending ABS.

Commercial & Esoteric ABS

• Tobacco Settlement Revenue Securitizations: Moody's proposed updates to its rating methodology.
• Container Lease ABS: The Hanjin Shipping Co. bankruptcy has limited negative effects on the sector.
• CMBS Market: Some CMBS-focused attendees expressed concerns about the retail industry, though challenges were seen as overstated.
• Residential Mortgages: Riskier non-QM loans are showing signs of slowing originations, but still producing notable volumes.

Additional Highlights

• ABS Issuance: September issuance volume outpaced the prior-year period, driven by strong market conditions and concerns about potential deterioration.
• Market Conditions: Attendees noted stronger market conditions than earlier in the year, influenced by low interest rates and investor behavior.
• Marketplace Lending: Some small platforms may shut down, and there are concerns about legal and data risks.

Conclusion

The ABS Spotlight October 2016 edition highlights the ongoing regulatory challenges and their impact on various ABS sectors, particularly auto lease ABS due to the Takata recall. While some sectors like credit card and student loan ABS show signs of increased risk, others, such as mobile phone financing and certain CMBS segments, are viewed as promising. The overall sentiment is cautious optimism, with market participants preparing for regulatory changes and potential shocks, but not expecting significant disruption.