Finance companies sometimes give grace to contract holders in hopes the individual can get back on the payment track since it’s potentially much more lucrative than having to go through the repossession and recovery processes.
Kroll Bond Rating Agency (KBRA) released a research report last Friday, examining the use of subprime auto finance extensions as a loss mitigation tool for ABS servicers. After taking a closer look at the performance of a specific provider, KBRA believes, in general, that the use of extensions ultimately benefits ABS investors by reducing delinquency and default rates.
However, analysts acknowledged a high rate of extensions within a securitized collateral pool can meaningfully increase bond duration and expose ABS investors — particularly owners of deeply subordinated tranches — to tail risks.
“As such, it is important for investors to understand each servicer’s policy regarding extensions, as well as how extensions are handled within ABS deal structures,” KBRA said.
Kroll Bond Rating Agency senior director of structured finance research Brian Ford shared the report with SubPrime Auto Finance News. Ford explained the project stemmed from the strategy used by Honor Finance in connection with its securitization launched in 2016.
Ford recapped that by early last year, Honor Finance granted extensions to as much as 22 percent of the contracts in the securitization, “well in excess of industry standards … which can mask poor collateral performance — i.e., by keeping delinquencies and default rates artificially low.”
Ford added in the report that “it is important for investors to understand each servicer’s policy regarding extensions, as well as how extensions are handled within ABS deal structures.”
The report touched on strategy employed by many finance companies regarding extensions. Some basic parameters often include:
— Customer must have paid a minimum of six to 12 contractual payments.
— Customer may not have had an extension during the preceding 12-month period.
— One extension occurrence of one or two months may be approved during any 12-month period, with a maximum of seven occurrences for contracts greater than 72 months.
—If the account is delinquent, the extension must bring the account completely current and resolve the delinquency at the time the extension is considered.
Ford pointed out that subprime issuers report monthly extension rates ranging between 2 percent and 6 percent. He added that most of the auto finance companies that KBRA rates actively monitor the success of their extension policy.
“Only a hand full of subprime auto loan securitizations contain specific structural triggers limiting the amount of extensions within the securitized pool,” Ford wrote in the report, referencing operations such as DriveTime and Tidewater.
“However, the legal final maturity of longest dated note class is typically set to equal the tenor of the longest receivable within the securitized pool, plus the maximum number of months that loan can be extended, per the issuer’s policy,” he continued. “Securitization documents typically include provisions that require the servicer to repurchase receivables that are extended past the maturity date of the bonds.
“Investors should understand each servicer’s extension policy and review transaction documents to determine what protections exist to reduce extension risk,” Ford reiterated.