A challenging macroeconomic environment and a series of internal and external factors over the past two years have have forced light vehicle sales and auto loan origination to take a pit stop. However, auto loan securitization might speed up as an alternative for originators to enhance their balance sheet management, diversify their funding sources, and secure better financing conditions going forward.

We expect Mexican auto finance securitization new issuance to remain in line with the volume observed last year, with auto leasing transactions leading new issuance. Albeit non-performing loans (NPLs; loans with delinquencies greater than 90 days) in auto loans started presenting signs of deterioration, they have historically over performed other consumer-related loans in Mexico, which could position them as one of the key candidates to step up to the podium.

Formation Lap: Auto Loan Market Overview

The entrance of new participants in the Mexican automotive industry and their rapid growth in terms of sales have changed the dynamics of what used to be a fairly concentrated market. As of the first half of 2019, the top five manufacturers comprised approximately 62% of total sales, compared to 74.5% in 2012. Nissan Motor Co., Ltd. has historically dominated the market, with a market share slightly above 20% of sales; General Motors Co. and Volkswagen AG hold the second and third place, respectively. However, all three have been losing market share over the last four years.

Auto loan originations have historically been dominated by nonbank financial institutions (NBFIs), many of them captive finance companies, which accounted for approximately 68% of the loans granted last year. Banks are increasing their participation on auto financing and accounted for about 28.5% of the origination in 2018. On the other hand, car self-finance (autofinanciamiento; financing funded through monthly installments made by a closed group of loan applicants) companies reduced their share of auto loan origination with the remaining 3.5%.

As of June 2019, there were 2.17 million auto loans outstanding, with an outstanding balance of $290.8 billion Mexican pesos (MXN), equivalent to approximately US$ 15.13 billion. NR Finance México, S.A. de C.V., Sociedad Financiera de Objeto Múltiple, Entidad No Regulada (NR Finance Mexico) has historically led the market as of the first half of the year, accounting for approximately one quarter of the outstanding loans, followed by GM Financial de México, S.A. de C.V., Sociedad Financiera de Objeto Múltiple, Entidad Regulada (GM Financial México) and BBVA Bancomer, S.A. (BBVA Mexico) with 18.5% and 17%, respectively. Table 1 summarizes the ten largest originators in the market and some of their portfolios' key characteristics.

Table 1

The macroeconomic environment and the competitive dynamics in Mexico are shifting origination standards in the market. Interest rates have increased over the past three years, following the hikes on the reference rate between 2015 and 2018. Similarly, auto loan originators are extending the tenors at which they are lending.

Loan-to-value (LTV) ratios are increasing but at a contained pace. As of June 2019, 24.8% of the outstanding loans were originated at LTVs between 70% and 80% while 23% was originated on the 80%-90% LTV range. These figures compare with their last three-year average of 25.1% and 22.8%, respectively. In our view, looser originator standards may result in increased defaults and delinquencies during stressful conditions.

From an operational perspective, the market is evolving while it takes advantage of new technologies. The proportion of loans collected via direct debiting has substantially increased to 84% as of April 2019 from 56% in 2015. We believe that loans collected through this mechanism pose less risk than those with voluntary payments as it reduces operational complexity from a servicing perspective. Table 2 details the evolution of the key origination standards in the Mexican market.

Table 2

Lights Out: A Slippery Track Caused Auto Loan Origination To Slow Down Since 2016

According to information from Instituto Nacional de Estadística Geografía e Informática, sales of light vehicles peaked in 2016 with 1.6 million units sold and have been losing speed since 2017. Light vehicle sales fell on a year-over-year basis in 26 of the last 27 months ending in August 2019. In our view, the next months will not be better; we estimate that car sales will close 2019 with a contraction between 8% and 9%.

A combination of macroeconomic and political events in Mexico have created a challenging environment for auto sales and, consequently, auto loan originations. For instance, 2017 registered the largest inflation rate (6.77%) since the global financial crisis, hampering household disposable income. Furthermore, a relatively high interest rate environment affected households' indebtedness capacity and demand for credit.

Finally, uncertainties derived from external and internal roadblocks have also affected the exchange rate and vehicle prices, particularly on imported vehicles, which accounted for 64% of total sales.

The downward outlook for interest rates in Mexico could speed up auto loan origination and ultimately allow auto finance securitization to retake lost ground from the past years.

Auto loan originations have historically been correlated to auto sales; however, auto financing has gained relevance when measured as a percentage of the total sales in the market. Before the 2008-2009 crisis, auto loans represented around 60% of total sales, which dropped to close to 50% over the years after the crises; since then, the percentage of financed vehicles has grown. As of 2018, approximately 68% of the vehicles sold were financed, which still lags the 85% in the U.S.

Chart 1

Lap 11: ABS Deals Backed by Auto Leases Overtake Auto Loans

We categorize auto finance-related asset-backed securities (ABS) in three main classes: auto loans, auto leases, and car self-finances (autofinanciamientos). Most of these deals are usually placed by lower-rated, smaller companies, with limited access to other types of funding and balance sheet capacity.

Auto loan transactions dominated ABS issuance between 2008 and 2010, mainly driven by captive finance companies that hold the largest portfolios. However, auto loan transactions have significantly dropped to the extent that we have not seen any new public deals since 2016. Autofinanciamientos experienced a similar luck over the past years.

On the other hand, transactions backed by auto leasing have maintained their momentum since 2011, presenting annual issuance of approximately MXN2.2 billion per year. It is common to see mixed portfolios that include auto leases and other equipment since volumes are still not enough to support product specialization by originators. For the purposes of our analysis, we excluded securitizations where the majority of the portfolio comprised equipment other than vehicles.

Auto finance securitizations gained relevance from 2011 to 2015. However, over the past two years, new issuance from auto finance securitizations collapsed compared to the levels observed between 2015 and 2017, in tandem with total structured finance issuance. When measured as a percentage of total structured finance issuance in Mexico, auto finance securitizations represented 9.4% in 2018 and 20.4% as of the first half of 2019.

Chart 2

We expect ABS deals backed by auto leases and other equipment to continue dominating new issuance in the next years, with 2019 volumes similar to those registered in 2018. On the other hand, auto loan securitizations have not recovered entirely due to the low cost of direct funding available to many captive finance companies and large banks, which implicitly reduces their appetite for securitizing their portfolios.

In our view, securitization might appear attractive for these entities from an asset liability management (ALM) and risk transfer perspective. Longer maturities on the financing contracts may trigger a new wave of securitizations for the coming years in an attempt from the originators to secure better financing conditions that match with the maturities of their assets.

Yellow Flag: Collateral Performance Begins To Show Signs Of Deterioration, But Still Over-Performs Other Consumer Loans

Auto loans have historically presented the strongest performance when compared to other consumer loans in Mexico, such as credit cards, personal loans, and payroll deduction loans; this is mainly due to the secured nature of these loans. According to information from Comisión Nacional Bancaria y de Valores, between 2012 and 2016, NPLs on auto loans granted by the banking system stayed stable between 1.4% and 2%, compared to consumer loans, with NPLs hovering around 4% and 5%.

Since 2017 NPLs for auto loans trended upward, peaking at 2.1% in May 2019, which remains in line with the historical performance for this asset class and still compares favorably with consumer loans. The adjusted NPLs, which account for nonperforming assets and charge-offs during the last 12 months, presented a similar trend. As of June 2019, the adjusted NPLs peaked at 5.2% for auto loans, while adjusted consumer NPLs were at 13.1% (see the dotted-line series in chart 3).

Chart 3

To date, we only rate one transaction backed by self-financing contracts originated by Sistema de Crédito Automotriz, S.A. de C.V. (SCRECB 16 and SCRECB 16-2). In our last rating action, in May 2019, we adjusted our BCL assumption to 9% form 8.66%, mainly reflecting the collateral performance, which was slightly worse than expected. Nonetheless, we affirmed the 'mxAAA (sf)' ratings on both classes, reflecting an increased capacity to withstand losses due to higher credit enhancement.

The performance of the other classes we rated in the past presented, in general, low NPL levels in all cases below our base case loss (BCL) assumptions. Consequently, our ratings remained stable as well. Our BCL assumptions for the ABS transactions backed by auto loans we've rated have hovered between 4% and 6.4% with an average of 5.2%.

We generally associate creditworthiness of these portfolios with origination standards; but, similar to other consumer loans, macroeconomic variables such as economic growth, unemployment, and inflation have a direct relation with their performance.

In our view, increasing unemployment will hamper the collateral performance and could translate into increased defaults. However, despite the upward trend, our unemployment forecast is still in line with the rates observed in the past. Increased inflation rates could affect the borrower's payment capacity and result in increased defaults. We expect inflation to close 2019 at 3.5% and to decrease in the next year, which could have a neutral effect on collateral performance.

We recently lowered our GDP forecast to 1.3% for 2019, down from 1.6%. In our downside scenario, we expect GDP to increase 0.8% in 2019 and 1.2% in 2020. If this scenario was to occur, or even under more stressing economic conditions, we anticipate that light vehicle sales and auto loan originations will further collapse, combined with an increase in collateral deterioration.

Table 3

Chequered Flag: Could Auto Finance Securitization Speed Up In The Next Race?

Auto loan securitizations did not rev up despite the good momentum auto sales registered up to 2016 and the high interest rate environment in the past years. Most manufacturers' captive finance companies benefit from a guarantee from their parent companies, which significantly increase their creditworthiness, limiting the benefits they can achieve via securitization from a cost reduction point of view. Commercial banks are less likely to securitize their auto loan portfolios since they have a balance sheet that can support this kind of lending.

For lower-rated originators like NBFIs and even smaller banks or captive finance companies, securitizations could arise as an attractive alternative by providing them access to more competitive financing terms and liquidity to support future growth. In our view, originators that use securitization as a financing tool on a frequent basis enjoy better financing terms and lower costs associated.

However, funding cost reduction is not the only benefit offered by securitization. As we mentioned earlier, the longer terms at which auto loans are being granted could make securitization more attractive for originators from an ALM perspective and could provide for better diversification of their funding. Banks and captive finance companies could also exploit the capital release benefits.

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