Auto ABS guide 2020

27 January 2020 Credit Research

Securitization Perspectives

UniCredit Research page 1 See last pages for disclaimer.

Auto ABS guide 2020

■ In our Auto ABS guide we provide an overview on the degree and development of importance of ABS funding in particular with auto-motive captives. Furthermore, we provide an abstract from our global ABS primary market overview before we touch base on spreads: we discuss factors that influence auto ABS valuations, we analyze under which circumstances recoveries tend to happen and how quickly. We conclude that spread volatilities driven by tar-iffs/geopolitical developments/auto ABS specific factors can hap-pen but should quite quickly be reverted by the effect of expansion-ary ECB policy.

■ With regards to primary market volumes, we expect EUR 14bn of publi-cally placed EUR denominated German auto ABS. For Italy, we consider our EUR 5bn forecast to be a conservative estimate – despite it repre-senting a record level for Italian Auto ABS. In combination with other auto ABS markets, we estimate global auto ABS supply of around EUR 27.5bn next year.

■ Secondary market trading for many types of bonds has suffered from a massive drought for quite some years now. The result is that the reliabil-ity of valuations in a phase of low primary market activity is diminishing, which in turn has an effect on the quality and reliability of indicative price talk in primary market deals – particularly those deals setting and end to a phase of low issuance activity.

■ The ECB is still increasing its portfolio. At the most recent publication date the ECB held an aggregate amount of EUR 28.4bn in ABS. In the early phase of the purchase program, the portfolio was largely acquired by way of secondary market purchases, however, to an ever diminishing degree. By the turn of the year 2018/19, positions acquired in primary market transactions began to outgrow secondary market purchases.

■ We expect the spread tightening in primary and secondary market to continue. We have our doubts that secondary market spreads can sub-stantially fall below the Euribor/EONIA rate. The reason is that although bank investors do try to diminish the opportunity cost of holding excess liquidity by investing at rates below Euribor/EONIA, there are more suita-ble targets available in the market away from the ABS sector. However, we also do not rule out that some ticket might be traded at small margins below Euribor-rate.

■ In terms of the primary market, we see a fair chance that senior tranches of German auto ABS will be priced in the area of mid-to-high-teens area, with the smaller European auto ABS markets being pegged to this devel-opment and find primary market levels roughly 6-10bp below of what we observe today.

■ Quite frequently, the MBS market is seen as being predisposed to having a green association. However, with regard to prime mortgage funding, Europe is rather a covered bond continent. Furthermore, a large part of the green mortgage business is also funded through promotional/state owned institutions. We see two sub-sectors as being more likely to bring about green securitizations: Auto ABS and CLOs backed by the growing market for green corporate loans.

Contents Situation of ABS funding in automotive captives 2Volume Considerations for Auto ABS in 2020 3Spread and Trading Considerations 7Green Auto ABS 13

SPREAD MOVERS IN SECONDARY TRADING

… AND THE REFLECTION IN PRIM. MARKET

Source: Bloomberg, Markit, UniCredit Research

Authors Florian Hillenbrand, CFA Credit Analyst Securitization (UniCredit Bank, Munich) [email protected] Franz Rudolf, CEFA Head of Financials Credit Research, Senior Credit Analyst Covered Bonds (UniCredit Bank, Munich) +49 89 378-12449 [email protected]

Bloomberg: UCCR Internet: www.unicreditresearch.eu

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Situation of ABS funding in automotive captives

Auto ABS can easily be considered the backbone of the European ABS market.

Auto ABS: an important in-strument for both ends of the value chain

The importance of the product effectively comes from both ends of the ABS value chain: asdisplayed in the table below, bonds are still the most important funding source for auto creditcompanies. However, when it comes to secured funding, ABS is the instrument of choicereaching funding shares of up to 40%. The average value is around 17-20% and is likely torise in the foreseeable future:

ABS are a funding instrument that is fairly independent of issuer rating

The increasing number of regulations and the sensitivity of these regulations to external rat-ings are increasingly pushing financial institutions towards funding tools that are fairly inde-pendent of the respective institutional rating. Even more than deposits, ABS fulfill this re-quirement of showing a lower sensitivity to the financial wellbeing of the originator. As exam-ple, in its fixed income presentation of 24 October 2019, Daimler indicated a funding target of10% deposits, 20% ABS, 20% bank loans and 50% capital market. At its current EUR 160bnin total funding, this would mean increasing its ABS funding to EUR 32bn* (from EUR 14.2bn*in 3Q19) and its deposits to EUR 16bn (from EUR 12.5bn in 3Q19).

*The figures are in excess of our supply estimate for we only capture volumes of publically placed tranches, whereas this is a global figure via many jurisdictions and both placed as well as retained

AUTOMOTIVE CAPTIVES FUNDING SITUATION

VW Group

VW Bank

VW FS BMW Daimler

Ford Credit GM Fin’l

Toyota MCC

RCI Banque

PSA Bq. France FCE Bank

1H19 1H19 1H19 1H19 1H19 1H19 1H19 1H19 1H19 FY18 3Q19 EUR bn EUR bn EUR bn EUR bn EUR bn USD bn USD bn USD bn EUR bn EUR bn GBP bn

CP/CD 12.0 0.7 2.7 2.1 3 3.6 28.4 1.4

Bonds 85.3 6.6 34.9 52.8 84.6 77.1 46.2 50.1 20.1 2.3 5.5

Bank borrowings 28.6 6.7 13.4 13.5 39.6 0.8 6.1 2.6 0.6

Other borrowings 11.3 12.7 19.6 3.1 5.8 3 5.5 1 2.7 4.8

Central banks 14.2 2.5 0.8

ABS 41.4 2.5 22.3 17.6 12.5 55.5 36.6 12.9 3.5 2.3 4.2

Deposits 30.4 33.8 0.1 14.5 16.7 2.3 2

Sum 209.0 63.0 93.0 103.6 159.7 139.2 89.1 97.5 47.8 11.0 16.5

CP/CD 5.7% 1.1% 2.9% 2.0% 1.9% 2.6% 29.1% 2.9%

Bonds 40.8% 10.5% 37.5% 51.0% 53.0% 55.4% 51.9% 51.4% 42.1% 20.9% 33.3%

Bank borrowings 13.7% 10.6% 14.4% 13.0% 24.8% 0.9% 6.3% 5.4% 5.5%

Other borrowings 5.4% 20.2% 21.1% 3.0% 3.6% 2.2% 6.2% 2.1% 24.5% 29.1%

Central banks 5.2% 7.3%

ABS 19.8% 4.0% 24.0% 17.0% 7.8% 39.9% 41.1% 13.2% 7.3% 20.9% 25.5%

Deposits 14.5% 53.7% 0.1% 14.0% 34.9% 20.9% 12.1%

ABS & deposits 34.4% 57.6% 24.1% 31.0% 7.8% 39.9% 41.1% 13.2% 42.3% 41.8% 37.6%

Source: Sector Thinking - Auto Finance in Europe: Resilient growth, funding needs and disruptive industry forces (w/audio) dated 9 January 2020, Bloomberg, company data, UniCredit Research

Auto ABS are the most active sub-segment

The result of the strong regulatory incentive to issue ABS is a comparatively active auto ABSmarket. As displayed in the chart below, primary market volume in the classical ABS universe(excluding CLOs) is increasingly skewed towards autos. Auto ABS is usually the largest sub-segment in the classic ABS market (excluding CLO).

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PRIMARY MARKET OFFERED VOLUMES DENOMINATED IN EUR (EUR BN)

Source: Concept ABS, Bloomberg, UniCredit Research

Volume considerations for Auto ABS in 2020

The following analysis was originally published on 29 November 2019 in our SecuritizationPerspectives – ABS issuance volumes into 2020.

The universe we dealt with in this outlook comprised all euro-denominated ABS, publically orprivately placed, as well as GBP-denominated ABS issued in the UK. Overall, we expectgross supply of EUR 89bn (6% higher than in 2019 YTD or EUR 5bn) in 2020. We expectAuto ABS to be the strongest factor for growth (EUR 14bn up 40%). CMBS will continue therebound (EUR 5bn higher), whereas we anticipate RMBS and CLOs to show reduced activity(decreasing by EUR 3bn and EUR 7bn, respectively).

SUMMARY OF ABS GROSS SUPPLY AND 2020 FORECAST

2015 2016 2017 2018 2019 2020 (exp.)

ABS 31,840 28,000 22,607 25,398 23,146 33,500

DE Auto ABS 14,156 10,420 7,931 9,560 10,400 14,000

European Auto ABS (excl. DE) 3,989 3,892 4,727 6,870 5,808 11,000

UK Auto ABS (EUR equiv.) 2,005 5,254 4,627 4,615 2,916 2,500

Consumer ABS 2,107 4,174 1,900 2,237 3,305 4,000

Other ABS 9,582 4,256 3,419 2,114 2,357 2,000

TOTAL European ABS and CLOs* 78,237 81,359 73,975 92,008 85,119 89,000

*excluding refinancing of old Northern Rock or Bradford and Bingley portfolios Source: UniCredit Research

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FACTORS INFLUENCING ABS ISSUANCE

*car loan or lease, property, consumer good, etc. Source: UniCredit Research

Factor analysis: propensity to consume is key,…

…refinancing periods are short… …and funding alternatives are not asset based

Auto ABS represent the most dynamic ABS market. Our chart of factors influencing ABS is-suance shows that for Auto ABS, the propensity to consume is pivotal.

Due to the relatively short life of the underlying loan business (usually around 1-3Y), the refi-nancing period of the receivables through ABS is quite short. Hence, new registration projec-tions from car manufacturers are rapidly reflected in ABS issuance activity.

Last but not least, funding alternatives for auto loans and lease business are not specific ornot asset based: senior debt capital market funding, bank loans or deposits. This is positivefor ABS issuance as we explain below.

PASSENGER-CAR REGISTRATIONS: WLTP CAUSED PEAK IN 2018

Source: Bloomberg, UniCredit Research

German Auto ABS continues to be the largest market

European car-loan registrations and receivables production is strongly skewed towards Ger-many. This is reflected in Auto ABS issuance, which so far this year stands at EUR 10.7bn forGermany compared to EUR 5bn for the rest of continental Europe.

WLTP caused a sales peak in 2018…

The peak in car registrations in 2018 was due to accelerated sales in preparation for theworldwide harmonized light-vehicle test procedure (WLTP). Consequently, the drop in 4Q18simply reflected a normalization following this artificial boost in sales. The ongoing weakeningthroughout 2019 was caused by a cyclical downturn. For 2020, LMC Automotive, expects aslight decline in light vehicle sales in western Europe (-1.0%), close to Moody’s, which ex-pects light-vehicle car sales in western Europe to decrease (by 3% compared to 2019). This isclose to the European Automobile Manufacturers Association (ACEA) expectation for EUpassenger car sales of -2% in 2020 (see weblink).

General economic picture

propensity to consume (a certain product*)

propensity to finance (a certain product*)

propensity of loan/lease originator to provide financing

Inclination of originator to use ABS as the re-financing device

Investor appetite for ABS

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…e-subsidies will be important in 2020…

On the policy side, the German government has announced its intention to expand subsidiesfor new pure e-cars. Not only will the rebate for purchasers of electric cars be increased, butthe entire scheme is also to be extended. The plan is for the bonus to be paid until the end of2025 – five years longer than previously intended. The bonus paid to purchasers of purelyelectric cars with a list price of under EUR 40,000 will rise from EUR 4,000 to EUR 6,000,while for cars with a list price of over EUR 40,000 it will be EUR 5,000. For plug-in hybrids, thebonuses will be increased to EUR 4,500 for cars with a list price of under EUR 40,000 andEUR 4,000 for those listed at over EUR 40,000. In addition, the German government intendsto put in place one million public charging stations, as laid out in its “Charging Structure Master-plan”, so that the target of ten million electric cars on German roads can be met by the end of thedecade. These measures, together with the pressure to achieve the EC’s CO2 targets should no-ticeably support new e-car sales from 2020, with the full impact coming in the following years.

EUROPEAN LIGHT VEHICLE CAR SALES FORECAST -

Source: LMC Automotive, UniCredit Research

…as will changes in convic-tions concerning funding mix on the issuer side.

As laid out above, ABS issuance is not only influenced by factors that affect the lending sideof the business. For originators/sponsors it is part of an overall strategy to find the optimalfunding mix. Explicit and implicit cost considerations play a role, but regulatory issues, termconsiderations, questions regarding funding diversification and visibility, among other factors,are equally important. Just recently, Daimler provided a practical example of how liability op-erations are adjusted to adapt to changes in external factors:

Daimler – sponsors of the Silver Arrow Auto ABS deals – reported a 3Q19 funding mix of 55%capital market funding, 25% bank loans and 17% deposits and ABS. In the quest to adjust thefunding mix to reduce its vulnerability to adverse changes in rating agencies’ credit assess-ments, Daimler communicated its target of 50% capital market funding, 30% deposits andABS, and 20% bank loans.

Apart from the conclusions that can be drawn from this policy change in terms of the relativeimportance of the factors influencing the optimal funding mix, it appears reasonable to as-sume that this consideration is not specific to Daimler. Other sponsors/originators might shareits aim of gaining a larger degree of independence from rating agencies.

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German Auto ABS to reach EUR 14bn in 2020

Hence, the overall car sales development, in combination with the support for e-cars, couldlead to a stable development of new car registrations in 2020, with 2019 issuance alreadyproviding a solid floor for 2020 issuance. Considering Daimler’s shifting its funding mix fromcapital markets and bank loans towards deposits and ABS, we have a strong argument formore pronounced issuance activity in Auto ABS in 2020. We expect EUR 14bn of GermanAuto ABS issuance.

AUTO ABS MARKET: WIDE DISPARITY BY COUNTRY AND BY ORIGINATOR

Auto ABS issuance by country (EUR bn)

VW as the backbone in an otherwise diversified originator landscape (EUR bn)*

*originators may be active in various countries Source: Bloomberg, ConceptABS, UniCredit Research

UK: – as with all other classes, it’s all about Brexit

GBP 2.5bn expected in 2020

When it comes to country-specific effects, without doubt, the UK will be the country with themost pronounced uncertainty. It all boils down to the question of a hard Brexit versus an or-derly Brexit. Quite obviously, a hard Brexit will lead to a more pronounced economic down-turn, which would take its toll on new car registrations and also be a drag on the ability andpropensity to consume.

We envisage that, due to prospective transitional regulations, an orderly Brexit, which is ourbaseline expectation, would place little additional burden on the economy. Consequently, weexpect growth in new car registrations and, consequently, new receivables production to beslightly below that of 2019. UK Auto ABS issuance in 2019 was just below GBP 3bn,GBP 2.5bn appears to be a reasonably cautious estimate for 2020.

We expect strong Auto ABS activity in Italy

EUR 5bn appears a lot, but we believe it is actually conservative

Italian Auto ABS issuance was EUR 2.9bn in 2019. Interestingly, the group of originators in2019 (FCA, BNP Paribas PF, MB, and Santander) had little overlap with the group of origina-tors in 2018 (FCA, VW, PSA). We expect FCA and PSA – maybe even in a joint effort – toreappear in 2020. Furthermore, we do not believe that Italian issuance from Daimler, Santan-der and BNP last year was a one-off. Together with the low but stable economic environmentand taking into account Daimler Germany’s argument regarding rating independence on thefunding side, we consider our EUR 5bn forecast a conservative estimate – despite it repre-senting a record level for Italian Auto ABS.

Issuance of French Auto ABS was sluggish in 2019 …but should accelerate in 2020: EUR 3.5bn

In France, 2019 issuance of Auto ABS fell substantially from EUR 3.1bn in 2018 toEUR 1.2bn. The captives of PSA (Banque PSA France and Credipar), RCI Banque (CarsAlliance) and BMW Bank (Bavarian Sky), which accounted for almost EUR 1.5bn in 2018, didnot re-appear in 2019. Neither did VW, which was responsible for EUR 500mn in both 2015and 2017. It appears that quite a few issuers have adopted a two-year rhythm of issuance,which would suggest 2020 might witness a substantial upswing in the issuance of FrenchAuto ABS deals compared to 2019. We expect the captives (including VW/Driver) to

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reappear, which might easily be good for EUR 2.5bn of issuance. Furthermore, SantanderConsumer (Auto ABS French Leases) and LeasePlan France (Bumper) are likely to reappear.In total, we estimate EUR 3.5bn as a realistic figure.

Spanish Auto ABS… …small but reliable market

EUR 1bn in 2020

Spain hosts quite an active Auto ABS market. Annual issuance is usually EUR 1-2bn. In 2019,activity has been comparatively subdued and so far we have only seen a EUR 555mn SantanderConsumer Spain Auto deal, which was preplaced and privately placed. Together with the Au-toNoria Spain 2019 the aggregate 2019 issuance volume of Spanish Auto ABS was EUR 1.5bn

For 2020, we consider it reasonable to assume that there will be a Volkswagen and aFCA/PSA deal. We are less certain about whether Santander consumer and AutoNoria willreappear in 2020. Hence our estimate of the aggregate volume is around EUR 1bn.

Other Auto ABS markets will likely provide EUR 1.5bn… …mostly from Finland

ABS issuance from other continental European countries accounted for only EUR 775mn in2019 – EUR 600mn less than in 2018 and a drop of more than EUR 1bn compared to 2017. Therecord low issuance in 2019 was due to a complete lack of euro issuance from the Netherlands(2017 EUR 574mn Lease Plan) and Austria (2018 EUR 522mn Porsche), among other factors.Effectively, the only continental European country to show reliable issuance activity was Finland,which was also the country of origin of the EUR 775mn Kimi 8 (Santander Consumer) issue.Based on the regular issuance from Finland, we could imagine a slight bounce back to aggre-gate levels of around EUR 1.5bn.

Spread and trading considerations

Finding the right price… Taking a look at economic textbooks, prices and therefore spreads of financial securities canbe observed in primary and secondary trading. Primary trading has the advantage of verifyingthe tradeable price based on huge amounts, but not very frequently. Price verification in sec-ondary trading, on the other hand, is based on highly frequent if not continuous trading ofsmaller sizes.

…when the secondary market is dry…

Secondary market trading for many types of bonds has suffered from a massive drought forquite some years now. Automated large-ticket trading in covered bonds is long gone, second-ary market turnover in the SSA sector is far smaller than it was some years ago and so is theABS market in general and the sub-segment of auto ABS in particular. The result is that thereliability of valuations in a phase of low primary market activity is diminishing, which in turnhas an effect on the quality and reliability of indicative price talk in primary market deals –particularly those deals setting and end to a phase of low issuance activity.

…for many reasons The reasons for the drought in secondary trading activity are manifold:

■ The general stance of the ECB of providing ample liquidity to market participants by way oflowering interest rates but also by expanding traditional open-market operations, increasesthe opportunity cost of holding liquidity and therefore increases the incentive for investorsto hold (financial) assets.

■ By becoming an active purchaser of securities, the ECB directly affects the availableamount of these financial assets.

■ Regulatory changes have discouraged financial institutions that act as market makers forfinancial assets to warehouse securities. Market making has shifted away from a ware-housing business towards an order-based business.

■ These days, the financial situation of banks in Europe is less benign than in the heyday ofbond market making. Hence, the allocation of equity to all kinds of investment bankingbusiness is lower than it was a few years ago – which, in a market-making context, alsonegatively affects the ability to warehouse bonds.




We list the most important aspects of the downturn in secondary market trading to illustratethe fact that the current situation is not likely to revert just because one of these aspectschanges. For instance, if the ECB were to stop the ABS purchase program, this would notlead to a upswing in volumes traded in secondary-market .

ECB purchase program has direct impact

However, since it is the factor that directly impacts tradeable volumes, we provide some detailon the ECB’s activity in the ABS market below (please also see the ABSPP Q&A section onthe ECB’s website):

■ ABS need to be eligible as collateral for the Eurosystem

■ Purchase decisions under the ABSPP take into account the outcome of the Eurosystem’sdue diligence analysis. The guiding principles are:

– collateral should be a diversified pool of granular and performing assets,

– security should be originated according to sound underwriting criteria,

– transaction structure is straightforward and robust,

– originator is in good financial health and shows regular presence in the ABS market,

– interest rate risks are mitigated,

– transaction documentation should clearly specify the processes and responsibilities and

– high degree of transparency

■ In any case, the Eurosystem retains full discretion to purchase or refrain from purchasingany ABS that meet the ABSPP’s eligibility criteria.

Tracking of purchases is almost impossible…

In a nutshell, it cannot be fully verified whether or not a certain ABS transaction fulfills the criteriaof the ABS purchase program. However, it is quite reasonable to assume that European autoABS transactions, as well as European prime RMBS deals, are plain-vanilla enough that there isa very high likelihood that they qualify for the ABS purchase program. Hence, the chart below,which depicts ECB’s ABS purchase program activities, can be associated quite closely with theissuance activity in the two European flagship ABS markets, auto and prime RMBS.

ECB ABS PURCHASE PROGRAM (AMOUNTS IN EUR MN)

Source: ECB, UniCredit Research

…but the big picture unveils… In the chart above, we plot two aspects of ECB purchases:

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Monthly auto ABS issuance lagged by 1 month (RS)

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…an ever increasing im-portance of primary purchases over secondary purchases.

On the one hand the central bank is still increasing its portfolio. At the most recent publicationdate the ECB held an aggregate amount of EUR 28.4bn in ABS. In the early phase of the pur-chase program, the portfolio was largely acquired by way of secondary market purchases, how-ever, to an ever diminishing degree. By the turn of the year 2018/19, positions acquired in pri-mary market transactions began to outgrow secondary market purchases. We are convincedthat the steady move towards primary market activities was not an active decision but rather theconsequence of secondary market positions having already been fully acquired by the ECB.

On the same chart, we display the development of net new purchases and plot them againstprimary market activity in the auto ABS market with a lag of one month. The reason for the lagbeing that the settlement standard of t+5 or more, in combination with internal processes atthe ECB, easily lead to a noticeable delay in reporting purchases. As displayed by the blackline compared to the red line, the peaks show increasing correlation the longer the purchaseprogram runs, reflecting the increasing importance of primary market purchases.

More equal split remains a goal The Governing Council decided in January 2017, that purchases of assets with yields below thedeposit facility rate could take place under the public sector purchase program (PSPP). In orderto increase the secondary market potential for purposes and also to try to achieve a more equalsplit between primary and secondary market purchases, on 12 September 2019, the ECB an-nounced that it would extend the possibility of buying assets with yields below the deposit facilityrate to all private sector purchase programs, including the ABS purchase program.

AUTO ABS SPREAD DEVELOPMENT – THE BIG PICTURE (VALUATION IN BP VS. 1M E)

Source: UniCredit Research

In the chart above, we plot the big picture of the spread development of European auto ABS.and the impact that major events in the past have had on auto ABS valuations. In fact weconsider it vital to put the spread moves into perspective – in particular, since such an exer-cise demonstrates what kinds of event have a sudden impact and which events do not:

ECB impacts both continuously and suddenly

In this context, one might be surprised that the launch of the ECB purchase program did nothave a noticeable impact immediately. Concluding that the ABS purchase program had or hasno impact at all, however, would be wrong. In fact, we consider the strong tightening post-Diesel-gate down to levels tighter than those observed before to be directly attributable to thestrong and continuous support from the ECB.

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Sep

12

Dec

12

Ma

r 1

3

Jun

13

Sep

13

Dec

13

Ma

r 1

4

Jun

14

Sep

14

Dec

14

Ma

r 1

5

Jun

15

Sep

15

Dec

15

Ma

r 1

6

Jun

16

Sep

16

Dec

16

Ma

r 1

7

Jun

17

Sep

17

Dec

17

Ma

r 1

8

Jun

18

Sep

18

Dec

18

Ma

r 1

9

Jun

19

Sep

19

Dec

19

German Senior Auto Loans and Leases ABSFrench Senior Auto Loans and Leases ABSDutch Senior Auto Loans and Leases ABSIrish Senior Auto Loans and Leases ABS

US‐China and US‐Eu

rope

tariffs discussionsDiesel‐gate hits

Auto ABS

ECB launches ABS

purchase program

"Whatever it takes"

ECB Tiering




In contrast, most recent developments at the ECB indicating a continued expansionary mone-tary policy including the two-tier system for remunerating excess liquidity holdings, appear tohave had a sudden impact. Spreads of the most populated auto-ABS indices we calculatewere halved from around 20bp to around 10bp.

For the sake of completeness, the most striking example of a sudden impact of central bankdecisions happened back on 26 July 2012 when the then president of the ECB Mario Draghiexpressed his famous words: “…whatever it takes…”.

US-China and US-Europe tariffs: slow widening – quick tightening

However, ABS valuations are also highly sensitive political and real-economy effects, includ-ing the following:

■ In July 2018, US President Donald Trump followed through on months of threats to imposesweeping tariffs on China. Over the 18 months since then, the two countries have beenembroiled in countless back-and-forth negotiations and the imposition of tit-for-tat tariffs. In1Q19, the situation calmed down somewhat, with negotiations being resumed and Chinasuspending additional retaliatory tariffs on US autos and auto parts, which were set tocome into force on 1 April 2019.

■ In 2Q/3Q18, President Trump frequently threatened to impose substantial (20-25%) tariffson cars coming from the European Union.

These tariff discussions were associated with the most pronounced widening in auto ABSspreads in the post-financial-crisis era. While the widening happened over an 18-month peri-od, the tightening back to levels close to where they were before the quarrel began happenedover a period of just three months.

PRIMARY MARKET AUTO ABS SPREADS BY COUNTRY

Source: UniCredit Research

SIL

VA

6 A

Loa

ns

VC

L 2

2 A

Le

ases

BS

KY

4 A

Le

ases

GL

DR

201

6-A

A A

Loa

ns

VC

L 2

3 A

Le

ases

BU

MP

7 A

Lea

ses

(w/

resi

dua

l val

ue)

BS

KY

GE

R4

A L

oans

SIL

VA

7 A

Loa

ns

RN

BLG

2 A

Le

ases

(w

/ re

sid

ual v

alu

e)

CO

MP

20

18-

GE

1 A

Lo

ans

AB

ES

T 1

6 A

Lo

ans

0

10

20

30

40

50

60

70

80

Jan-15 Jul-15 Jan-16 Jul-16 Jan-17 Jul-17 Jan-18 Jul-18 Jan-19 Jul-19 Jan-20

Issu

ance

spr

ead

(bp

)

Germany Spain Finland

France Italy

US‐China and

US‐Europe

tariffs discussions

Diesel‐gate hits

Auto ABS

ECB Tiering




Diesel gate: quick widening – slow tightening

The opposite in terms of pace happened with Diesel-gate:

■ When the news hit that many auto manufacturers had gamed statistics about the environ-mental performance of their products, uncertainty about residual values of vehicles and thefinancial wellbeing of car manufacturers led to a sudden widening. From trough to peaktook less than three months.

■ The comeback, however, took a lot longer. Effectively, spreads came back to pre-Diesel-gate levels roughly six months after they peaked.

Primary market valuation has less pronounced peaks

At the beginning of the chapter we made reference to the textbook understanding of primary vs.secondary market trading. In fact, we observe some of these classic aspects in the charts above:

The spikes that are characteristic for the valuation based on continuous trading of comparablysmall-sized tickets (secondary market) appear to be less pronounced when observing primarymarket transactions.

No more “lemons-problem” as demonstrated by Diesel-gate

What we do observe is that the uncertainty about residual values following Diesel-gate affect-ed primary market spreads of auto lease ABS a lot more and for a lot longer than it did autoloans. Transactions that included residual values were most affected and suffered the longest.Although this might appear to be stating the obvious, we consider it an important point. Thelow degree of selectiveness with which investors treated ABS during the depths of the finan-cial crisis and the resulting “lemons-problem” is the key reason that the regulators imposedregulations to fight this type of risk. However, either by way of regulations that have alreadytaken effect, or by investors acting in a more sober and educated way, the selectiveness inrough times has improved and thus the risk of fundamentally unaffected deals being consid-ered guilty by association.

Market participants are robust enough to weather “slow-widening” situations

The last aspect we want to cover is how primary market spreads react to situations such asthe tariffs conflict. In situations of slowly widening primary and secondary market spreads,primary market deals still take place up to a certain point. Leasing ABS VCL 27 A was pricedat a spread of 22bp in October 2018, while at the same time PBD had to pay a newcomer’spremium and priced its inaugural at 1M Euribor +24bp. In the midst of the storm, ABEST 16was placed at a spread of +40bp vs. 1m Euribor, coming from an IPT of +30bp. After that, themarket was closed for more than four months. We interpret this situation positively. The keytakeaways are:

■ auto finance companies are strong enough to weather crises;

■ despite difficult times, investors do not shy away completely but can be incentivized byslightly higher spreads; and

■ the higher spreads paid on such a transactions does not jeopardize the financial wellbeingof the transaction.

Spread situation going forward: how tight is tight?

The fact that both primary and secondary market spreads are at multi-year lows should not betaken as sufficient reason to assume that further tightening would not be possible. We believethat the first question that needs to be answered is about certain barrier levels at the tight endof the spreads. An example of such a barrier that has already been broken is zero yield. Ef-fectively each of the barriers we look at in the following both come with a psychological (whichwe mention now for once and then no more) but also with a fundamental justification:

■ Negative yield: Spread compression on the one hand and 1M Euribor falling below thelevel of -37bp back in May 2019 led to a situation in which negative yields were already amarket reality for large parts of senior tranches of auto ABS. This barrier is particularly crit-ical for real money investors as investing in such an asset means not only losing money inreal terms but also in nominal terms. In other words, only bank accounts, leveraged fundsand central banks can still make reasonable investments at these levels.




■ Euribor/EONIA flat: at the moment, primary market spreads even of the tightest deals, are still somewhat off this level. However, secondary market trading has already observed lev-els in the low-single-digits. Euribor flat is particularly critical since this is the break-even level for many leveraged accounts (bank investors, leveraged funds). With 1m Euribor at -0.451% and EONIA at -0.452% a differentiation between these two reference rates is cur-rently not necessary. Investing below 1M Euribor/EONIA can effectively only be justified based on diminished opportunity cost. However, space below 1M Euribor/EONIA is limited. Excess liquidity held with the ECB is charged -0.5%, which is equivalent to 1M Euri-bor/EONIA -5bp.

■ ECB deposit rate: arguing for spreads below the ECB deposit rate is certainly a tough task. Tough because there is hardly any economic justification for investing. On 12 September 2019, the ECB extended the possibility of buying assets with yields below the deposit facili-ty rate to all private sector purchase programs – however, it goes without saying that the ECB purchase program is not aiming for profitability but is a monetary policy tool.

How soft is the market? Looking at the richening side as well leads us to the question of what might initiate the kind of spikes that occurred, for example, in 3Q18. Moreover, if such spikes were to occur, would there be a bounce back and what would be the time frame?

First, we are convinced that whatever triggers a spike in spread development, as long as ECB policy remains expansionary, there will be a bounce back – and effectively, this is also the answer to how soft the market is: basically it is quite hard.

However, the robust foundation of the market does not make it immune to fallbacks:

■ We doubt that recurring trade-tariff disputes will have a similar effect on auto ABS spreads as they did in 3Q18. The effect back then was not fundamentally justified in auto ABS but was rather a reflection of a general fear of an economic slowdown. The quick recovery we observed in 1Q19 should also provide investors with confidence and thus prevent a signifi-cant widening in the first place.

■ Geopolitical aspects always have to be considered. However, this type of risk is usually associated with expansionary central bank policy – which takes us back to the reasoning above and therefore argues for it being a temporary phenomenon.

■ Direct fundamental factors such as a general economic slowdown, affecting the car loan/lease business, default rates etc. tend to affect the lower tranches of auto ABS deals. We do not anticipate senior tranches being noticeably or sustainably affected, especially since any economic downturn should support expansionary central bank policy.

Base scenario: primary to fall below 20ies, secondary floored at Euribor -ε

We expect the spread tightening in primary and secondary market to continue. We have our doubts that secondary market spreads can substantially fall below the Euribor/EONIA rate. The reason is that although bank investors do try to diminish the opportunity cost of holding excess liquidity by investing at rates below Euribor/EONIA, there are more suitable targets available in the market away from the ABS sector. However, we also do not rule out that some ticket might be traded at small margins below Euribor-rate (mathematically described as Euribor –ε).

In terms of the primary market, we see a fair chance that spreads for senior tranches of Ger-man auto ABS will be in the mid-to-high-teens area, with the smaller European auto ABS market being pegged to this development.




Green Auto ABS

The following is a summary of our Securitization Perspectives – Green ABS: Sector situation and AFME’s ideas.

The green MBS market is likely to be a second/third choice

Many market participants see the MBS market as the most likely to be predisposed to havinga green association. Certainly, in terms of its size, it has the largest potential in this regard.However, with regard to prime mortgage funding, Europe is rather a covered bond continent.Hence, if funded through wholesale markets, the green mortgage business will more likelyfind its source in green covered bonds. However, a large part of the green mortgage businessis also funded through promotional/state owned institutions. Hence, Europe’s green MBSmarket will always be a second, if not third, choice after the direct issuance of sub-sovereign/agency or financial/non-financial debt. This means that a strong push in favor ofgreen ABS will likely come from elsewhere. We see two potential areas: Auto ABS and CLOsbacked by the growing market for green corporate loans.

Others appear to be more promising: e.g. Auto ABS…

Among other factors, the ever-improving performance of batteries for electric vehicles anduncertainty due to fraud in the development and production process of conventional cars haveboosted sales and registrations of alternatively fueled vehicles (AFV), and particularly for elec-trically chargeable vehicles (ECV). Therefore, it appears to be only a question of time before acritical mass is reached in green auto loans – i.e. the point at which it makes sense for origi-nators to consider refinancing via a separate green Auto ABS program. The enhanced subsi-dies for ECV purchases that have been indicated for Germany should further spur the market.

NEW PASSENGER-CAR REGISTRATIONS BY EU MARKET

All ECVs and HEVs* AFVs other than ECVs**

*includes battery electric vehicles, extended-range electric vehicles, fuel cell electric vehicles, plug-in hybrid electric vehicles, full/mild hybrids (HEVs) **includes natural gas vehicles, liquefied petroleum gas-fueled vehicles, ethanol (E85) vehicles Source: national automobile manufacturers’ associations

The registration figures displayed above support the view that it is just a question of time.However, unfortunately, market dynamics are not always as plain and simple as they seem:

Auto ABS transactions are relatively small and require some 50,000 contracts or more toserve as collateral. This compares to a total of 222,427 new ECV and HEV registrations in thepast four quarters in Germany. Hence, the 50,000 contracts required to serve as collateralwould represent 22% of these cars registered in Germany in the last four quarters, however,only a fraction of them are financed via loans or leases. Furthermore, these cars are producedby a number of manufacturers. Hence, despite this impressive increase in new registrations,we are still far from the point at which critical mass is likely to be achieved. Still, the figuresindicate that the development of this sector is certainly on the path towards achieving this.

0

50,000

100,000

150,000

200,000

250,000

300,000

350,000 Germany France UKItaly Spain NetherlandsSweden All other

0

10,000

20,000

30,000

40,000

50,000

60,000

70,000

80,000All other Poland Germany

Spain Italy

https://www.research.unicredit.eu/DocsKey/credit_docs_9999_175118.ashx?EXT=pdf&KEY=n03ZZLYZf5miJJA2_uTR8rAEz2vgAV1Gc5pO6PNlito=&T=1�




One obstacle to the achieving critical mass is the size of the market for ECVs and HEVs; an-other is regulatory. There is a lack of standardization across green loan contracts.In this context, EU taxonomy will be supportive. Applying clear and harmonized standards(once they are in place) to green loan contracts would make the bundling of assets morestraightforward, i.e. it would reduce the due diligence required when loans are bundled to-gether, and improve the standardization of risk evaluation. This could even counter an insuffi-cient market size.

Technical development poses another hindrance to the development of the market for greenAuto ABS. As stated above, technical development is supportive because it tends to leadpeople to consider purchasing an AFV. However, the more rapidly that technical improvementtakes place, the higher the uncertainty that originators have to cope with when determiningresidual values of vehicles. While originators/sponsors can cope with fluctuations in the pricesof used cars (triggered by short-term shifts in supply and demand), unforeseeable technicalimprovement could lead to the prices of used cars falling to zero and maximizing losses fororiginators. Therefore, the market for, and the development of, ECVs and HEVs probablyneeds to stabilize before reasonably strong activity in the market for Auto ABS can take off.




Previous Securitization publications

» Sector Flash - ABS: Comments on 2020 early bird issuance - 14 January 2020

» Sector Flash - ABS: Dutch RMBS paving the way in 2020 - 8 January 2020

» Sector Flash - Securitization/Italian consumer ABS: Moody´s positive on CDQ/DP loans - 3 December 2019

» Securitization Perspectives - ABS issuance volumes into 2020 - 29 November 2019

» Sector Flash - Securitization: FCA/PSA merger supportive for captives´ ABS - 7 November 2019

» Securitization Perspectives - Green ABS: Sector situation and AFME´s ideas - 5 November 2019

» Sector Flash - Securitization: Another Brig in the wall - 10 October 2019

» Sector Report - Securitization: ABSsentials - Understanding STS - 9 October 2019

» Securitization Flash - EBA fighting the “dreadful four” - 1 October 2019

https://www.research.unicredit.eu/DocsKey/credit_docs_9999_175638.ashx?EXT=pdf&KEY=n03ZZLYZf5miJJA2_uTR8nhNV3afkzVfgRAsfEBryhA=&T=1�

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Dr. Ingo Heimig Head of Research Operations & Regulatory Controls +49 89 378-13952 [email protected]

Head of Credit Research

Dr. Sven Kreitmair, CFA Head of Credit Research +49 89 378-13246 [email protected]

Financials Credit Research

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Corporate Credit Research

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Auto ABS guide 2020

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