Amid a Weakening Trend, Subprime Auto ABS Performance Varies by Lender

SECTOR IN-DEPTH Auto ABS - US Amid a Weakening Trend, Subprime Auto ABS Performance Varies by Lender Executive Summary TABLE OF CONTENTS Executive Summary 1 More high-loss transactions from smaller lenders are raising aggregate loan losses in subprime auto ABS Subprime auto underwriting continues to weaken overall, with larger balances and longer loan terms Smaller lenders with rising losses face risks even amid stability of the broader market Loan pools in many transactions that we rate are performing better than, or consistent with, our initial expectations 1 3 4 4 Aggregate net loss rates in the subprime auto asset-backed securities (ABS) sector are increasing; however, much of the overall performance deterioration is a result of an increased number of ABS transactions from smaller lenders that cater to deep subprime borrowers who have particularly weak credit. In contrast, loan pools from the larger subprime lenders are performing consistently within our expectations. An increasing willingness by some lenders to lend to weaker-credit borrowers, as evidenced by increasing loan balances and longer loan terms, is also contributing to rising transaction losses in aggregate. Worsening transaction performance poses the greatest risk to smaller lenders that rely on securitization for funding, especially if the current favorable economic conditions that are helping borrowers make their payments begin to weaken. Andrew S Miller 212-553-2796 Associate Analyst andrew.miller@moodys.com Among transactions we rate, most of the loan pools, particularly those sponsored by AmeriCredit and Santander, the two largest subprime auto ABS lenders, are performing within expectations. However, the loan performance in deals we rate from smaller lenders Consumer Portfolio Services, Incorporated (CPS) and CarFinance Capital has generally weakened. In CPS's case, the weakening is partly a result of changes that the company made to its servicing practices following its 2014 settlement with the Federal Trade Commission (FTC) stemming from allegations of aggressive debt collection tactics. However, in both the CPS and CarFinance transactions, a mitigant to the higher loss rates is the build-up in credit protection from structural features such as non-declining reserve accounts and from sequential payments that benefit senior bondholders. Corey Henry VP-Senior Analyst corey.henry@moodys.com More high-loss transactions from smaller lenders are raising aggregate loan losses in subprime auto ABS Contacts Peter McNally 212-553-3610 VP-Senior Analyst peter.mcnally@moodys.com Anna Burns Associate Analyst anna.burns@moodys.com 212-553-7813 212-553-2723 As subprime auto ABS issuance has shifted over the last several years to include an increasing proportion of transactions from sponsors that lend further down the credit spectrum, many of them relatively small entities, the average loss rate for subprime auto ABS transactions has risen overall. As Exhibit 1 shows, the average annualized monthly net loss rate for transactions in the sector, with each transaction receiving equal weight, climbed to about 11.2% as of January 2016, up from 8.8% in January 2015 and 7.8% in January 2014.

Exhibit 1 Average Monthly Losses in Subprime ABS Are Rising Transactions closed since 2010 * * Based on transactions with publicly available performance data. Sources: Moody s Analytics, Moody s Investors Service, Bloomberg Several 2015 transactions have had relatively high early losses, contributing to the increasing average loss rate in the sector. For example, smaller lenders Global Lending Services (GLS), GO Financial, and Skopos Financial issued their first transactions in 2015, all with relatively high early losses. These lenders' five 2015 transactions together totaled about $1 billion in securitized loans at closing. Also in 2015, Santander issued four transactions of deeper subprime loans under its Drive Auto platform, the first securitizations from that platform since 2008. Those transactions were relatively large, with a total securitized loan value at closing of about $4.5 billion. Loan performance varies significantly across subprime ABS transactions because different lenders may lend to populations with very different credit profiles; therefore, generalizations about performance can be misleading. The securitized pool losses of subprime auto ABS sponsors range from less than 10% for lower-loss lenders to nearly 30% for deep subprime lenders. Deep subprime lenders extend loans to borrowers with very weak credit, often with FICO scores of 550 or less. Exhibit 2 shows that an increasing number of sponsors, many of which are smaller lenders that focus on lending to weaker-credit borrowers, have issued ABS transactions in the past several years. Sponsors with transactions with relatively high losses include DriveTime Automotive (DT), American Credit Acceptance, United Auto Credit, and CarNow Acceptance. The exhibit includes all announced transactions, including those without publicly available performance data, from 2010 to 2015. This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page on www.moodys.com for the most updated credit rating action information and rating history. 2

Exhibit 2 Subprime Auto ABS Issuance Includes Increasing Number of Smaller Sponsors By sponsor, number of transactions Source: Moody's Investors Service The proportion of transactions from the two largest subprime auto ABS sponsors, AmeriCredit and Santander Drive, fell to 21% of all transactions in 2015, down from 31% in 2013 and 69% in 2010. This trend has led to a higher average loss rate in subprime auto ABS because the loan pools of these two sponsors generally have lower-than-average losses. Over the 12 months ended January 2016, average net loss rates in AmeriCredit and Santander Drive s transactions were 4.19% and 6.90%, respectively, lower than the overall subprime ABS average of 8.84%. Measured according to dollar volume, Santander Drive and AmeriCredit account for the majority of securitized loans. Together, Santander Drive transactions ($36 billion, or 37% of securitized loan volume) and AmeriCredit transactions ($27 billion, or 28%) make up nearly two-thirds of the loan receivables in securitized subprime auto ABS issued between 2010 and 2015, even though these two lenders' transactions account for only about one-third of the number of total transactions. Santander Drive and AmeriCredit transactions, which are typically larger than $1 billion, are much larger than most other sponsors' transactions. Subprime auto underwriting continues to weaken overall, with larger balances and longer loan terms The increasing willingness of some subprime auto lenders, particularly smaller lenders, to lend to weaker-credit borrowers is contributing to rising transaction losses in aggregate. The overall deterioration in borrower credit quality is consistent with a typical expansionary lending phase, during which lenders gradually expand credit following a downturn, until losses reach a point at which further competition for weaker borrowers is unprofitable. Low losses on post-crisis loan originations from 2010 and 2011, along with low interest rates that kept lenders cost of funds down, meant higher profits that enticed new lenders to enter the market and compete for borrowers. One way that lenders continue to take on risk is by catering to cash-strapped customers through larger loan amounts and extended loan terms that reduce monthly payments. By underwriting larger loan balances, lenders are at risk of greater losses if the borrowers default. According to data from Experian, the average amount that subprime borrowers financed for new vehicle loans was about $28,200 in the fourth quarter of 2015, up from $27,400 in the fourth quarter of 2014 and $26,900 in the fourth quarter of 2013. The average amount financed for used vehicle loans rose to about $16,100 in the fourth quarter of 2015, up from $15,900 in the fourth quarter of 2014 and $15,500 in the fourth quarter of 2013.1 By lengthening the periods for borrowers to repay loans, lenders are also at risk of greater losses in the event of borrower default because the customer pays the loan back more slowly. The average term for new vehicle loans for subprime borrowers was 72.2 months in the fourth quarter of 2015, up from 71.6 months in the fourth quarter of 2014 and 70.8 months in the fourth quarter of 2013. The average term for used vehicle loans rose to 60.9 months in the fourth quarter of 2015, up from 60.0 months in the fourth quarter of 2014 and 59.1 months in the fourth quarter of 2013.2 3

Smaller lenders with rising losses face risks even amid stability of the broader market If favorable economic conditions continue, they will help subprime auto lenders avoid sharply increased losses by buttressing loan performance, but a weakening economy will exacerbate performance problems of weaker-credit borrowers. Although job gains help borrowers remain current on their loans, a rise in unemployment could increase the number of borrowers who can no longer make payments, especially considering that the longer loan terms and larger loan balances suggest that borrowers are increasingly stretching their budgets to afford their vehicles. Weakening transaction performance poses the biggest risk for smaller lenders that rely on securitization for funding. Rising loan losses can present acute operational risks for smaller lenders because a sponsor or servicer with limited resources can more quickly lose the ability to efficiently manage loan and transaction cash flows. When losses rise quickly, smaller lenders may have trouble servicing a loan portfolio that requires more attention and greater servicing capacity, especially if the portfolio has grown rapidly. Losses may rise even higher if a funding crisis forces an auto finance company to fail or exit the lending business. If losses mount to levels much higher than historical averages, smaller lenders that rely on securitization will have trouble obtaining funding. If investors lose confidence in the lender s ABS because of loan losses and concerns about the company s viability, the lender s cost of issuing ABS will become prohibitively expensive, or the lender will lose access to the ABS market altogether. Similarly, other sources of funding, such as equity or bank lines, will also become expensive or unavailable because investors and banks will reduce their exposure to the lender, especially given the disappearance of the ABS financing option. Financial weakness can increase ABS transaction losses because a financially strapped lender will have fewer resources to increase its servicing capabilities to deal with more problem loans in its portfolio. In addition, losses increase when the servicer is financially unable to honor its obligations under the transaction s representations and warranties to repurchase defective loans. Even if the servicer can meet its repurchase obligations, it will more likely seek to avoid its obligations if its financial situation is dire. Further, failure of the lender will result in a servicing transfer that can disrupt collections and loss remediation efforts. A back-up servicer available to step in immediately if the original servicer defaults can mitigate the risk of potential servicer disruption, but even a timely transfer will likely have a negative effect on a portfolio s credit performance. Loan pools in many transactions that we rate are performing better than, or consistent with, our initial expectations Most subprime auto ABS transactions that we rate, namely those sponsored by AmeriCredit and Santander Drive, are experiencing losses lower than or consistent with our initial expectations. As Exhibits 3 and 4 show, cumulative losses have been consistent on AmeriCredit transactions issued since 2012 and on Santander Drive transactions issued since 2010. Both sponsors transactions have outperformed our original expectations: our average current lifetime pool loss expectation on the outstanding AmeriCredit transactions that we rate is 8.4% of the pool s original loan balance, down from our average initial expectation of 9.7%, and our average current lifetime pool loss expectation on the outstanding Santander Drive transactions that we rate is 13.8%, down from our average initial expectation of 15.7%. Santander s four deeper-subprime transactions, issued out of its Drive Auto shelf in 2015, are also performing within our initial loss expectation of 27%. 4

Exhibit 3 Exhibit 4 AmeriCredit ABS Net Cumulative Losses Are Consistent Santander Drive ABS Net Cumulative Losses Are Consistent Sources: Moody s Analytics, Moody s Investors Service, Bloomberg Sources: Moody s Analytics, Moody s Investors Service, Bloomberg Even as credit trends in the subprime auto lending industry weaken overall, AmeriCredit and Santander s pool characteristics have been steady. Borrower FICO scores for loans included in the two lenders' transactions have remained consistent over time, although the payment terms on the loans have lengthened gradually. The loan performance of other transactions that we rate, those sponsored by CPS and CarFinance Capital, has weakened, although the rated bonds credit enhancement is adequate to support their ratings. Over time, we increased the average lifetime pool loss expectations on the outstanding CPS transactions that we rate to 16.2%, from our average initial expectation of 14.1%. CPS's loan performance has deteriorated in part as a result of servicing changes that the company made following its 2014 settlement with the FTC. We also raised our average lifetime pool loss expectations on the outstanding CarFinance Capital transactions that we rate (series 2013-1 and 2013-2) to 12.0%, up from our average initial expectation of 11.5%. Exhibits 5 and 6 show the net cumulative losses on the CPS and CarFinance Capital transactions that we rate. 5 Exhibit 5 Exhibit 6 CPS ABS Net Cumulative Losses Have Risen Since 2011 CarFinance Capital's 2013 ABS Net Cumulative Losses Are Slightly Above Initial Expectations Sources: Moody's Analytics, Moody's Investors Service Sources: Moody's Analytics, Moody's Investors Service

Even though the loan performance in the CPS and CarFinance Capital transactions has weakened, structural elements of the ABS have allowed them to build up credit enhancement. As the transactions pay down, the credit enhancement available to the bonds builds up because non-declining reserve account balances and over-collateralization increase as percentages of the outstanding collateral balances. Transactions with sequential-pay structures also benefit the senior bonds with a build-up of enhancement and faster paydown relative to pro rata-pay structures. Over the lifetime of the transactions, we have upgraded most of the CPS- and CarFinance Capital-sponsored bonds that we rate, especially those issued in 2013 and earlier. 6

Endnotes 1 Source: Experian Automotive, State of the Automotive Finance Market Fourth Quarter 2015 and Fourth Quarter 2014. 2 Ibid. 7

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