Auto financing has quickly emerged as a key component of Australia's securitization market. This segment has historically been minor, but the entry of nonbank originators has spurred issuance and increased the number of nonbank originators lending in the sector. S&P Global Ratings believes two trends to watch will be the resale values of electric vehicles and greater challenges in servicing debt while cost-of-living pressures persist.

Car Ownership Is High In Australia

About 91% of Australian households own at least one vehicle, according to the Australian Bureau of Statistics' Census 2021. This partly reflects lengthy commuting distances, particularly in regional areas with limited public transport networks.

Cost-of-living pressures and higher interest rates have dampened new-car sales. S&P Global Mobility predicts that light-vehicle sales in Australia will decline by about 3% in 2025 as economic uncertainty weighs on demand (chart 1).

Chart 1

Structural shifts in auto financing drive competition

The Australian auto financing sector has undergone a structural shift in the past three years. Banks have for the most part divested the more regulatory capital-intensive and noncore assets such as auto receivables, opening the way for greater nonbank financing of motor vehicles. This has stoked more competition in the auto-financing space, with several new nonbank originators coming to market.

Auto loan ABS issuance has subsequently increased (chart 2).

Chart 2

Weaker economic conditions have failed to stem auto loan ABS issuance, which new and established auto ABS issuers have frequently used to fund growing auto loan portfolios. Regular issuance and consistent performance will help with benchmark note pricing.

Emerging Trends Affecting Auto ABS

Electric vehicles are making incremental inroads into new vehicles sales

Internal combustion engine (ICE) remains the dominant vehicle type in Australia, representing about 74% of total new-vehicle sales (chart 3). This share is falling, albeit incrementally. Across total new-vehicle sales, hybrids are growing faster than battery electric vehicles (BEVs) due to concerns about charging infrastructure; so-called range anxiety, given the larger distances people must travel in Australia, particularly in regional areas; and lower resale values linked to the risk of technological obsolescence in BEVs.

Chart 3

BEVs and hybrids account for a larger share of motor vehicle sales than heavier passenger vehicles such as trucks, according to the Australian Automobile Association.

BEV penetration also varies across the country. The highest penetration of BEVs is in the capital cities of southeastern Australia, particularly the Australian Capital Territory (ACT), which has the highest BEV penetration rate, according to Australian Automobile Association data. The ACT's smaller area and the generally higher income of its residents may influence these trends.

Government policy has also increased the adoption of BEVs. These include exemptions for zero-emission vehicles (ZEVs) and plug-in hybrid electric vehicles (PHEVs) from custom duty, provided their value is below the luxury-car tax threshold. The Australian government also offers exemptions for fringe benefit tax on ZEVs and PHEVs for qualifying vehicles priced below the government's luxury-car tax threshold (PHEV exemption ceases on April 1, 2025).

In addition, the federal government also indirectly offers discounted car loans for the purchase of new ZEVs and PHEVs through cheaper funding provided to lenders via Clean Energy Financing Corp.

Favorable tax treatment for low-emission vehicles has accelerated the adoption of EVs under novated leases--a popular form of car financing in Australia (see below). The exposure to electric vehicles across Australian auto loan ABS transactions varies. Transactions with higher exposure to EVs are typically those with a higher proportion of novated leases. To date, the highest exposure to EVs across an Australian auto ABS transaction is about 17%.

Regulatory Change Likely To Drive Up Electric Vehicle Sales

On Jan. 1, 2025, a New Vehicle Efficiency Standard will take effect, with the accumulation of units and potential penalties starting on July 1, 2025. Under the standard, each vehicle manufacturer must meet or exceed emissions targets for all new cars they produce. The standard aims to reduce emissions from cars over time by increasing the take-up of more fuel-efficient, low- or zero-emission cars. The standard brings Australia in line with most other advanced countries.

The government expects that these initiatives, like its tax exemptions, will increase the adoption of more full-efficient cars. If so, this is likely to lead to a higher proportion of EVs in auto loan ABS receivable pools.

Resale Values Of EVs Under Pressure Across The World

Given the low volumes of EVs in Australia, used-car price data for this fuel type is more limited. In larger regions, such as Europe and the U.S., used-vehicle prices for EVs have been more volatile and the cars have greater depreciation compared with ICE vehicles.

When first launched, EVs were expensive because of their high production costs, and low demand elasticity for early adopters. With more manufacturers and more models across various segments for the mass market, competition has led some manufacturers to slash new vehicle prices to maintain market share (see "Electric Vehicles Amp Up European Auto ABS Risk," published on RatingsDirect, Nov. 29, 2023). This has caused prices of secondhand electric vehicles to fall. On average, a low supply of used EVs may have supported historical residual values. As supply increases, demand may not keep pace, leading to lower secondhand prices.

Battery health may also be significantly affected by charging behavior, and this remains a concern for EV users. Batteries are one of the most expensive components, representing about 30%-50% of the electric vehicle price ("Electric Vehicles Amp Up European Auto ABS Risk," Nov. 29, 2023). Some factors may alleviate these concerns. They include proposals such as third-party battery health certificates, extended manufacturer battery warranties, and studies suggesting slower degradation rates than manufacturers initially forecast.

In Australia, the lower penetration rates for EVs and limited data history add to the volatility in used-car prices for this fuel type Given the low exposure to EVs in most Australian auto loan ABS transactions, we generally do not apply additional haircuts to recovery assumptions for EVs. In cases where the exposure to EVs has been greater than 10%, we have applied additional haircuts to recovery assumptions.

Characteristics Of the Auto Loan Market In Australia

Main market participants

The auto financing market is typically served by captive or noncaptive entities (table 1).

Table 1

In terms of market share, noncaptive financiers are the predominant providers of auto financing and the main securitizers in Australia. This differs from Europe where captive finance dominates issuance (chart 4).

Chart 4

Types of auto financing

Most auto financing contracts in Australian auto loan ABS transactions are fixed-rate contracts. Auto finance in Australia can take the form of loans or leases provided by commercial banks, nonbank originators, OEMs, and other financing companies, which are extended to retail and commercial customers, for new or used vehicle purchase. Across Australian auto loan ABS transactions, the most common types of auto finance contract are as follows.

Consumer loans:  Personal loans used to finance specific assets including vehicles.

Chattel mortgages (commercial loans):  Business (or mostly business use) loans typically used to finance vehicles or equipment.

Finance leases:  This involves the lessor purchasing an asset such as equipment or vehicles and then leasing it to a lessee for a specified duration. The finance company (lessor) typically owns the asset during the lease's tenure. At the end of the lease term, ownership rights are transferred to the lessee.

Novated leases:  A common form of financial lease in Australia, which has inherent tax benefits. Under a novated lease, the lender/financier is the legal owner of the vehicle and leases it to the obligor. The obligor novates the lease to their employer, which is responsible for paying the lease instalments from the employee's pre-tax salary.

The employer can make the lease payments directly to the lender, or through a salary-packaging company. The employee remains responsible for all maintenance and other expenses of the vehicle and has the option of packaging these costs into the lease contract and monthly payments via a fully maintained novated lease, though these are less frequently included the receivables pools for transactions that we rate.

Green loans:  Some lenders offer so-called green loans for the purchase of low-emissions vehicles. The CEFC offers discounted funding to originators to finance these loans.

Chart 5

Additional risk considerations for novated leases include employer concentration risks and salary-packager concentration risks. Depending on the size of the concentration, we may adjust our analysis by increasing our loss expectation. A salary-packager insolvency may delay the receipt of cash flow if the company becomes insolvent before collections are remitted to the trust. This could increase liquidity risk. To account for this, our cash flow analysis may stress the delay in payments for the relevant novated lease portion of collections.

Operating leases are not common in Australian auto loan ABS transactions. Most leases are financial leases whereby the lessee is the ultimate owner of the vehicle. This is different to an operating lease where the purpose of the lease type is the simple use of the vehicle and the lessors remain the vehicle's legal owners. Operating leases contain residual value risk. If the leases are securitized, we would stress residual value risk in our analysis.

Balloon payments are common in contracts

A balloon payments is a single repayment at the end of a loan term. Balloon payments are more common in Australian auto financing, but they mainly adhere to Australian Taxation Office guidelines--not affordability or loan-servicing considerations. This is because payments are tax-deductible for a finance lease (or other auto financing contract for business use), and the tax guidelines specify minimum balloon percentages, based on the contract term.

All balloon payments are an obligation of the borrower. As a result, unlike operating leases, the transactions are not exposed to market-value risk associated with the sale of the motor vehicles for performing receivables. We consider the proportion of contracts with balloons as well as the aggregate proportion of balloon payments in a transaction and may make an adjustment to our expected loss to address the additional default risk associated with a large proportion of balloon contracts or balloon amounts.

Guaranteed future value contracts

Originators are increasingly offering guaranteed future value (GFV) contracts whereby the borrower can return the vehicle for a pre-determined price. Under a GFV contract, the manufacturer typically determines the vehicle's minimum future value based on the brand, estimated mileage, and model. At the end of the contract period, most manufacturers offer three options:

• An upgrade to a new car.
• Keep the car (payment is based on the GFV).
• Return the vehicle to the dealer. To mitigate the risk of excess depreciation, GFVs typically assume an agreed mileage, which may incur a fine if exceeded, and prescribe servicing guidelines and vehicle condition.

We are yet to see a material proportion of these contracts flow into securitization. Similar to standard balloon contracts, higher exposure to GFV contracts warrants additional analysis and potential adjustments to our expected loss.

Asset Types

Most assets financed in Australian auto loan ABS transaction are motor vehicle; however, some transactions include other assets. These may include heavy trucks, recreational vehicles, machinery, and small equipment. The composition of asset types financed varies across originators. The mixed asset types in Australian auto ABS transactions reflect economies of scale and business dynamics. The smaller loan sizes for asset financing, and Australia's comparatively smaller population, result in more mixed pools to generate economies of scale, which is a prerequisite for securitization funding.

We analyze each of these segments separately. For instance, we use different loss and recovery expectations for auto assets than we do for equipment assets. We also see different percentages of consumer versus commercial contracts across transactions.

Australian auto loan ABS transactions include a mix of new and used vehicles, the split of which varies across originators. We typically analyze loss and recovery data separately for new versus used asset types.

Table 2

Loan Characteristics

Key portfolio statistics derived for Australian auto loan ABS transactions include the following (table 3).

Table 3

The maximum loan-to-value (LTV) ratios permitted for auto loan financing are typically much higher than residential mortgage loans. LTV ratios greater than 100% are common. In addition to 100% of the vehicle being financed, add-ons and insurance may also be included in the auto financing. Contract tenors for motor vehicles are much shorter than residential mortgage loans (i.e., three to seven years compared with 30 years), which reduces lenders' credit exposure. Motor vehicles are also more liquid than property.

Origination, Underwriting, And Servicing

Origination

Depending on the originator, origination channels include dealers and novated lease introducers, auto and equipment finance brokers, dealerships, and direct origination. The respective originators are responsible for all credit decisions. No dealer or introducer is given any credit authority. Most originators receive applications electronically. Applications typically pass through an electronic scoring system or credit decisioning engine. A proportion of applications are referred to members of respective credit teams, in line with their delegated lending authorities.

As part of our operational review of auto and equipment lenders, we look at the lenders' years in business, strategy, and growth rates. Periods of higher growth may understate losses. This is adjusted for in our analysis.

Underwriting

Automated decisioning/score cards are typically the first line of credit filtering. Scorecards are a quantitative credit-scoring system for credit assessment. Credit rules underpinning scorecard approaches may leverage credit bureau frameworks or use a combination of credit bureau rules supplemented by lender specific criteria. Although loan approvals under automated processes are expedient, cooling off periods often apply, enabling consumers time to change their mind before taking delivery of the vehicle.

Typically score cards will generate a risk-tiering score for borrowers. This score is used to determine pricing, and whether a loan needs to be referred to a credit team for further assessment. Based on the credit score and internal policy rules, the credit-scoring system automatically approves, declines, or refers the case for manual assessment. Lenders' generally conduct ongoing refinements of scorecards to better predict borrower behavior.

As consumer auto finance lending must comply with the Australian Securities and Investment Commission's (ASIC) responsible lending guidelines, serviceability calculations for individual borrowers are often like those used in residential mortgage lending. This is particularly the case for lenders that also originate residential mortgages as it enables them to leverage existing operational and credit platforms. Income and expense data is collected from borrowers.

Expenses are typically benchmarked against household expenditure measures. All financial obligations of borrowers are also considered. A net surplus is typically required to proceed. As most auto finance contracts are fixed-rate contracts, serviceability buffers are not typically included in debt-serviceability assessments, unlike residential mortgage loans. In addition to scorecard rules, borrower applications must also meet lender policy guidelines including loan-to-value ratio limits, maximum amounts financed, age of vehicle at contract maturity and so on.

Chart 6

The credit assessment process for commercial borrowers is more lender-specific since it does not fall under ASIC's responsible lending guidelines. For commercial borrowers, greater focus is placed on business financials, length of operating history, credit reference checks, and debt-servicing coverage ratios. Property ownership is preferable in many instances as is the presence of a guarantor. Lenders may also have restrictions on the types of industries financed with more volatile industries typically excluded. Credit decision-making is typically less automated for commercial loans, given the higher level of subjectivity.

Across most originators, all applications including system auto-approved loans have income, employment and capacity verification completed prior to settlement. All securities are typically registered as first ranking security interests on the Personal Property Securities Register.

Since the 2017 Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry, there has been a crackdown on lending standards across consumer finance asset classes. This has led to tighter underwriting standards, with more emphasis on expense verification. Unlike residential mortgage loans, where underwriting criteria tends to be more standardized and prescriptive across originators, underwriting standards are less homogeneous across auto finance originators. This reflects the different product markets they operate in, and more diversified product types.

Weaker underwriting standards would typically manifest in higher gross losses over time. Since prior loss experience heavily influences our base case loss determinations, we aim to understand any changes in underwriting policies during the period covered by the loss data. This helps us assess the trajectory of future loss performance, and whether past performance is a reliable marker of future performance.

Servicing

Originators are responsible for the servicing of the assets, which is typically done in-house. Some originators outsource day-to-day collections processes to specialist collections agencies. Early-stage collections typically occur via text messaging, email, and telephone. Late-stage collections and hardship are typically managed in-house by specialist teams. Most originators engage mercantile agents for repossessions and auction houses to liquidate repossessed assets. The management of these relationships can be done in-house, via a third party or an accredited panel.

Chart 7

The average time from repossession to sale of vehicles varies. Anecdotal feedback from lenders is that this process typically takes 30-90 days in Australia.

Most Australian auto loan ABS transactions have a back-up servicer in place. Back-up servicers include Perpetual Corporate Trust Ltd., AMAL Asset Management Pty Ltd., and BNY Trust Co. of Australia Ltd.

Understanding losses and recoveries

Net losses equal gross losses minus recoveries, where recoveries equal the proceeds from the asset sale (minus selling costs). Typically, a gross loss is recognized when a default occurs. Usually when a gross loss is recognized, a net loss is also recognized in that month, and the net loss reduces in subsequent months once the asset has been sold and recovery proceeds are received. After this point, our net loss analysis doesn't include any other amounts received by pursuing the borrower.

We look at historical gross loss data for vintages that have been paid off and projections for those that are yet to pay off. We generally analyze historical loss performance on a segmented basis--by specific collateral characteristics or contract types. The overall base case gross loss is then determined using a weighted average based on the actual composition of the pool.

Understanding the timing and method of recognizing gross losses is a key part of our credit analysis. Questions we consider include:

• How consistent is the timing and recognition of losses across the portfolio?
• When is the defined point when a gross loss is recognized (e.g., 120 days in arrears)?
• Are gross and net losses recognized in the same month?

In determining the base-case gross loss assumptions, we consider several factors, including:

• Performance volatility.
• Economic environment.
• Vintage outliers: Can they be explained?
• Performance trends.
• Relevance of the data to serve as a basis for our projections.
• Pool characteristics versus the composition of historical data.
• Peer comparisons.

We calculate recoveries using the originator's historical gross and net loss data. We apply haircuts to base-case recovery rates because in periods of greater economic stress, it is less likely that the issuer will benefit from receiving the full recovery proceeds. S&P Global Ratings standard haircut to base recoveries at a 'AAA' rating stress is 50% for motor vehicles and 75% for trucks. Credit to recoveries is not generally given for equipment loans.

Transaction Structures And Features

Auto loan ABS transactions usually have a shorter term than other asset classes and are characterized by fast deleveraging.

Static and revolving transactions: risks and mitigants

In Australia, most auto loan ABS are term transactions that amortize immediately after closing. Revolving transactions' collateral can potentially deteriorate during the replenishment phase. Although we account for this potential deterioration risk in our credit and cash flow analyses, portfolio parameters and early amortization triggers are typically tight, and mitigate this risk.

Sequential amortization and pro rata features: risks and mitigants

In Australian auto loan ABS, provided certain performance conditions are met, principal repayments can occur on a pro rata basis to all or a defined selection of notes. The conditions to allow prepayments can include:

• A documented subordination percentage for the most senior notes that needs to be reached before pro rata can occur.
• A documented 90-day arrears test that if breached requires the transaction to revert from pro rata to sequential principal payment.
• The payment date is before the call-option date.
• There are no outstanding principal draws, charge-offs, or carryover-charges offs to any notes.
• The documented cumulative default ratio is not breached.

Sequentially amortizing transactions feature an immediate build-up of credit enhancement for the senior notes that increases over time. On the other hand, pro rata transactions initially build, but then maintain a constant level of credit enhancement, accelerating amortization of the subordinated notes. Pro rata transactions may lead to increased tail-end risk for the senior notes if defaults occur later in the transaction's life. For this reason, we normally conduct additional credit stability analysis where pro rata structures are proposed.

Commission notes

Many Australian auto loan ABS transactions include commission notes. The commission notes are issued, uncollateralized, to fund unamortized commission expenses in respect of the receivables acquired. Before an event of default or enforcement of the general security agreement, interest and principal due to these notes is paid solely out of the income waterfall. Principal repayments are made according to a controlled amortization schedule and rank senior in the waterfall. Any unpaid principal amounts from prior payment dates will also be due. The commission notes can receive further payment of principal, until the invested amount has been reduced to zero, should excess spread be available for this purpose.

Credit enhancement

Primary credit enhancement in Australian auto loan and mixed equipment ABS is provided in the form of note subordination, and excess spread when it exists. Overcollateralization is also provided as credit support in some transactions. In addition, rated ABS transactions also have liquidity reserves and a principal draw feature to meet short-term liquidity risks.

As outlined in our global auto ABS criteria, auto loan ABS transactions are subject to the credit support floors outlined in table 4.

Table 4

Asset Performance To Remain Stable Amid Low Unemployment

The collateral performance of the Australian auto loan and mixed equipment ABS sector has been stable, as shown by relatively low arrears across most transactions (chart 8). This is despite higher interest rates and cost-of-living pressures. The fixed-rate nature of underlying contracts in Australian auto loan ABS has insulated it from the rapid rise in interest rates during 2022 and 2023. Since many borrowers will also have variable rate residential mortgage loans, rising interest rates and higher inflation at the household level are constraining household budgets, adding to debt-serviceability pressures for some borrowers, as the modest increases in arrears indicate.

Chart 8

Across the various segments/subsets common in Australian auto loan ABS transactions, performance trends include:

• Historical losses for new motor vehicles financed are lower than those for used motor vehicles.
• Novated leases historically show lower levels of gross/net losses relative to other products. This is because repayments are automatically deducted from borrowers' pre-tax salary by their employers.
• Longer-term loans tend to be correlated with higher default or lower recover rates.
• EVs have lower arrears. This will partly reflect the higher incomes of early adopters, given the higher prices of earlier models.

In the wake of the financial crisis, the Australian auto loan and mixed equipment ABS sector has shown a positive ratings bias, with upgrades exceeding downgrades for the past 10 years. Given the deleveraging and shorter tenors of these transactions, the average change in credit quality for this consumer asset class has been mostly positive.

S&P Global Ratings forecasts unemployment in Australia to rise to 4.5% in 2025 from 4.1% in 2024, based on year average forecasts. This will have downstream effects on debt serviceability. We expect arrears across consumer asset classes to rise as unemployment increases.

We anticipate unemployment will stay below pre-pandemic levels. As such, any increases in arrears are likely to be modest and should not lead to rating deterioration in the auto loan ABS sector.

Related Research

• Economic Outlook Asia-Pacific Q4 2024: Central Banks To Remain Cautious Despite U.S. Rate Relief, Sept. 23, 2024
• Electric Vehicles Amp Up European Auto ABS Risk, Nov. 29, 2023
• A Primer on European Auto ABS, Nov. 21, 2023
• A Primer On China's Auto Loan Asset-Backed Securities Market, April 28, 2022
• Auto ABS Arrears Statistics: Australia, published monthly