How Empty Is the Glass? Experience Level Is Found to Influence Sensitivity to Subprime Auto Market Deterioration and Downgrades

S&P’s recent downgrade of Class E notes from CPS Auto Receivables Trust (CPSART) 2016-B, 2016-C, 2016-D and 2017-A from BB- to B+ is prompting investors to take a closer look at other deals. It also prompted us to go back over the data from our 360 degree market study to see which constituency group will be most sensitive to the latest news.

We found significant differences in the way participants with less than five years’ experience view the sources of risk relative to participants with over five years’ experience. For simplicity, we’ll call the first group “New Participants” and the second group “More Seasoned.”

Beyond citing to poor performance which led to higher than expected losses, S&P speculated that improved levels of credit extensions may have actually contributed to the delinquencies. This echoes an area of concern we heard from participants in our survey. Although overall, participants expected credit extensions to have a positive effect on deal performance, New Participants were more wary of extensions relative to More Seasoned participants, with only 58% of New Participants believing in the positive effect, versus 71% in the More Seasoned group. The contrast was most significant among Trustees, where only 40% of New Participants believed the effect would be positive, versus 72% in the More Seasoned group.

Further contrasts we’ve uncovered between the groups:

  • New Participants were more likely to believe future downgrades would occur, with Trustees who are New Participants significantly more likely to believe there would be more downgrades on the horizon than Trustees in the More Seasoned group (80% versus 50%). Further, Lenders, Investors and Trustees in the New Participant group were more likely than their counterparts in the More Seasoned group to believe downgrades will be caused by the failure of credit enhancements.
  • New Participants were much more sensitive to recent downgrades relative to the More Seasoned group, especially in the Lender group (80% versus 40%), stating downgrades affect their activity.
  • New Participants are more likely than those in the More Seasoned group to stress credit ratings are the most important factor for success of a securitization.
  • Investors who are New Participants were more concerned that credit enhancements will not protect investors from losses on subordinated tranches.

Despite the relatively greater sensitivity to ratings and negativity regarding downgrades and credit enhancements exhibited by New Participants, it was the More Seasoned group that was much more likely to believe performance would deteriorate further and that credit enhancements will need to increase in the future to obtain desired ratings.

Thus, it appears that less experienced participants are more sensitive to ratings and their importance, yet they are more likely to be content with current credit enhancement levels to obtain desired ratings. More experienced participants, on the other hand, generally want to see greater coverage levels.

Looking Ahead

The rationale for the CPS downgrade is reflective of the higher loss expectations we observed in our Subprime Auto 60 Second Review for other deals, including for 2016 deals from Exeter Finance, American Credit Acceptance and Prestige. Based on the results of our study, if there are catalysts for change in the market, it will be the heightened sensitivity of the New Participants who have not had first-hand experience of long periods of prosperity, and the desire for change from More Seasoned participants, whose past experience allows them to identify when a change in the market requires the market to adjust its practices.

Emily Hatchett, a paralegal in the Insolvency, Creditor’s Rights and Financial Products Group, assisted with this post.

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