Subprime auto finance got another smack in the face last week when Moody's Investors Service reduced its rating on a key portion of asset- backed securities designed to stimulate investor interest in the sector.
Moody's downgraded $5.65 million worth of securities from the subordinated debt portion-or "B piece"-issued by Aegis Auto Finance Inc., Jersey City.
The ratings agency cited higher than expected losses and deliquencies in the pool of loans backing the securities as reason for the downgrade to Ba1 from Baa2. The rest of the $175 million deal, rated triple-A because it is insured against default, is unaffected.
Moody's said the trustee for the securities, Norwest Corp., is currently taking steps to ensure that investors will be repaid in the event Aegis should go bankrupt.
The B piece downgrade, which Moody's analyst Kuman Kanthan said was the agency's first, bodes ill for subprime auto lenders seeking to recapitalize their tarnished businesses.
In the past year, high-yield B pieces have played a big role in attracting buyers of subprime auto asset-backed securities, a vital financial lifeline for the industry.
Over $10.1 billion in securities were issued by subprime auto lenders in 1996, according to Moody's, a 54% increase over 1995. To attract investors, subprime auto financiers began tacking B pieces onto their securities more than in previous years, the rating agency said.
In effect, B pieces have served as insurance for the senior portion of a security, or A piece. Although B pieces are usually backed by the same auto loans as is senior debt, Moody's analyst Jay Eisbrook said, if the loan portfolio starts to experience losses loans from the B piece are transferred to shore up the A piece.
This de facto insurance coverage has become increasingly important because the deluge of subprime auto securitizations has greatly exceeded the willingness of bond insurers like Financial Securities Assurance Inc. and MBIA Insurance Corp. to guarantee the deals against default. Insurance enables below-investment-grade companies to offer triple-A rated securities and attract investors they couldn't otherwise get.
But the standard form of insurance coverage costs up to 20 basis points. Some subprime auto lenders have opted to pocket those points and attract investors by offering bigger high-yield B pieces instead.
"If an investor is saying 'Do I really want to buy this?' issuers can sometimes get them by jacking up the B piece," said Jeffrey P. Salmon, asset-backed-securities analyst at UBS Securities.
The Aegis downgrade is likely to heighten skepticism over an area of finance that has already burned many investors.
"Will this make it harder for them (Aegis) to sell securities in the future? Without a doubt," said Fred Hoffman, vice president at Alliance Capital Management.
Buyers are looking to invest in higher-quality credit than a year ago, he said, and the recent problems in the consumer finance sector, particularly at Advanta Corp., the credit card issuer, have shaken up enough investors that interest in speculative subprime auto deals has dimmed considerably.
Despite the latest signs of trouble in subprime auto lending, Mr. Eisbrook of Moody's said securitization issuance in the field "continues unabated."
But the size of deals has shrunk considerably from a year ago, he said, because the lenders are originating fewer loans these days.
