Question

You are a finance employee at a financial institution, specializing in originating auto loans in a country where auto loans have only been available for 2 years. Your group has just been informed that a close competitor has securitized $150 million in auto loans through an investment bank.

• Your boss wants to understand why the competitor did this. Explain.
• He also wants to understand the potential benefits for the following:
  • The issuer
  • The investors buying the ABS
  • The individual borrowers seeking auto loans
• He also wants to know the likely impact to the auto loan market in this country if a large, liquid ABS market emerges over the next few years.

Answer 1

Securitization is creation of an asset which can be sold to investors from which revenue can be generated. It is a liquid instrument compared to selling an auto loan directly. The issuer would be able to raise money quickly by selling this liquid security. Obviously, the instrument would have to be credit rated based on the quality which depends on the financial condition and the issuers ability to repay the loan.

The investors buying the security can get indirect exposure to the auto market without having to directly lend. Securitization increase the availability of the loan by the investment bank. If the demand for securitization rises more number of auto loans will be pooled together to create a security. The auto loan market will boom if a liquid ABS market emerges over the next few years. However, if interest rates drop, the borrowers would start prepaying their auto loans or refinance the existing loans at lower rates. There is a prepayment risk in such a scenario