Question

1. According to a report from WSJ, investors are gobbling up auto loans extended to the riskiest borrowers, looking past market warning signs as they reach further for returns. In 2018, investors have been buying subprime auto securitization deals that offer slices with single-B credit ratings, well into junk territory and the lowest grade offered when such bonds are sold. Auto lenders have issued $318 million worth of single-B debt in 2018, more than all prior years combined, according to data from Finsight. Subprime auto deals, often bought by large money managers and other institutional investors, are typically backed by loans to borrowers with FICO scores below the mid-600s. Because these borrowers are at higher risk of default, the bonds tied to their loans can offer higher yields. Typically such bonds are subdivided into various layers, each with a different level of risk and return based on the order in which they receive payments.

Should investors be concerned that the amount issued in 2018 exceeds the amount issued in all prior years combined? Should government regulators be concerned? Why or why not? Given that borrowers tended to pay car loans even as they defaulted on their mortgages, do the single-B ratings overstate the risk of investing in the bonds? Why or why not?

Answer 1

1. Auto lenders have issued $ 318 million worth of single - B Debt

2. Money Managers have bought above mentioned subprime auto securitisation deals.

A Now Investors (Money Managers) should not be concerned about the amount of the securitisation deal issued by the Auto Lenders because

a) It is not one Auto Lender which is issuing the securitisation deals.

b) All the securitisation deals issued by the Auto Lenders have different risk return profile and the investor can invest in them as per risk return appetite.

c) The return form securitisation deals are completely backed up by the interest paid on the auto loans by the borrower, hence the return on securitisation deals are complete secured.

d) Borrowers are prefering to pay Auto Loan over Mortgage Loan.

e) Even Auto Loans are secured becaused the loan is extended against the vehicle as security, hence even in case of default the loan amount can fully be recovered.

f) The return on such securitisation deals are high.

B The government regulator not should be concerned because of the following reasons.

1. Auto lenders have issued $ 318 million worth of single - B Debt which is a very small fraction of the GDP.

2. Volume of above mentioned securitisation deals can easily be covered by the reserves maintained by the Government.

3. Vechicle loan itself is secured hence the loss due to default is negligible.

5. Pay out of the securitisation deals are fully backed up by the pay in of the vehicle loans.

6. There will be no cascading effect even if the borrower is unable to pay the outstanding amount.

C The only concern of the government regulator could be the high return because it can divert the investors away from goods secured assets but with relatively low return.