S&P Global Ratings expects COVID-19 to initially affect certain segments of the U.S. commercial asset-backed securities (ABS) sector more so than others. The commercial ABS sector encompasses a wide variety of industry and equipment types and servicers, ranging from small-ticket independent lessors to larger-dollar captive financing companies. We believe that ABS transactions originated by small-independent finance companies, regardless of specific equipment type--especially those with exposure to "nonessential" small businesses (e.g., the restaurant and hospitality industries)--are most at risk of immediately experiencing elevated levels of deferrals, delinquencies, and losses.

S&P Global Ratings acknowledges a high degree of uncertainty about the rate of spread and peak of the coronavirus outbreak. Some government authorities estimate the pandemic will peak about midyear, and we are using this assumption in assessing the economic and credit implications. We believe the measures adopted to contain COVID-19 have pushed the global economy into recession (see our macroeconomic and credit updates here: www.spglobal.com/ratings). As the situation evolves, we will update our assumptions and estimates accordingly.

The Small-Ticket Equipment Segment Will Be Hit First

The COVID-19-induced economic dislocation will have a negative effect on the financial position of small businesses as federal and state governments have ordered nonessential businesses to close and residents have been advised to stay home. This will impair the ability of small businesses in these affected areas to continue operations and make timely payments of expenses. The recent passage of the CARES Act may help small businesses cover existing debt payments, but it remains to be seen if these measures are enough for them to continue operating and remain current with their existing financial obligations.

We believe that the COVID-19 virus will have a greater immediate impact on ABS transactions concentrated in the small-ticket equipment sector, especially those that may have direct exposure to nonessential businesses. That said, small-ticket ABS collateral pools are diversified by equipment type (e.g., office equipment vs. titled vehicles equipment) and industry (e.g., manufacturing vs. finance and insurance), which should provide some cushion against those experiencing immediate economic stress.

About 10% of the total new-issuance volume rated by S&P Global Ratings in 2019 comprised small-ticket ABS, with an average contract balance typically below $20,000. Of the total commercial equipment ABS volume outstanding, only 16% represent small-ticket ABS rated bonds. For those businesses that provide financing to other parts of the commercial equipment space (i.e., auto fleet lease, production agricultural equipment, and large-ticket equipment, such as enterprise servers), these collateral pools may experience elevated levels of credit stress if the economic disruption is prolonged.

The table below breaks out typical commercial equipment ABS segments for S&P Global Ratings rated transactions and our corresponding view of the risks we are monitoring, along with mitigating factors.

Servicer Actions

We expect servicers to actively work with affected obligors by means of payment deferrals granted on a case-by-case basis. These payment deferral requests are likely to be concentrated in the small business segment and will consist of two types of deferral. The first type is an outright payment deferral, with deferred payments added to the end of the contract. The second mirrors the first option but also includes nominal payments made during the deferral period. The second deferral type is preferable, as it keeps the obligor engaged during the deferral period. The maximum deferral period offered by servicers will likely range from 30 to 90 days. We expect to see little or no deferrals offered at this time by other segments of the commercial equipment ABS space due to the stronger liquidity profile of the obligors compared to those in the small business segment.

Effect On Outstanding Commercial ABS Transactions

The overall performance impact of COVID-19 will only begin to show in the March collateral performance report that we will receive in April. To the extent servicers begin to make deferrals to contracts in the outstanding securitization pools, the impact on performance will initially stress the liquidity mechanics of the transaction structures. Where deferrals are provided, any liquidity stress should be mitigated by the benefit of reserve accounts that range from 0.50% to 1.00% of the initial pool balance for small-ticket transactions, which can cover two to eight months of senior fees and interest expense assuming no payments are received. Additionally, since all collections of principal and interest on the collateral is pooled together and available to cover monthly senior fees and interest expense, this provides further liquidity coverage. However, if the economic disruption is prolonged, those collateral pools including deferred contracts may experience elevated levels of credit stress.

While we don't rely upon loan/lease substitutions in our ratings analysis, some servicers may substitute new collateral for modified contracts in securitization pools, while others will elect not to substitute or are prohibited from substituting based on their transaction documentation. We expect those issuers with the strongest liquidity profiles and the ability to access other funding sources to be most likely to remove and replace modified contracts. Substitution of deferred or defaulted contracts may have a positive impact on securitization collateral pool performance and is likely to support existing ABS ratings, to the extent the performance of the substitute collateral is not adversely affected by COVID 19. As such, we will continue to closely monitor the ability of servicers to actively mitigate collateral deterioration and the potential effects on their associated commercial equipment ABS transactions.