New vehicle registrations of passenger cars and light trucks fell substantially in March as a result of the disruptions caused by the coronavirus disease (COVID-19). The fall in registrations and the expectation that many car dealerships will be closed in the short term will likely prolong this effect and have a direct impact on the performance of DBRS Morningstar-rated auto wholesale transactions backed by these vehicles in Europe, Canada, and the U.S. The vehicle manufacturers associated with these publicly rated transactions are Renault S.A. (BBB – UR Neg.), Ford Motor Company (BBB – UR Neg.), and General Motors Company (BBB (high) – UR Neg.).
Auto wholesale transactions rely on the turnover of vehicles held by dealers during the revolving period. Ordinarily, as the inventory turns, the proceeds from retail sales are used to repay the wholesale loans and new loans are advanced as the dealer purchases new inventory from the manufacturer. However, the environment created by the coronavirus has fundamentally affected this cycle as (1) car dealerships have been required to close by governments or have elected to close following stay-at-home guidelines, (2) there are movement restrictions placed on the general public and only essential travel is allowed, (3) economic uncertainty has delayed big-ticket purchases, and (4) some vehicle manufacturers have suspended production at their plants across Europe and North America.
With dealerships closed and stock levels remaining constant, DBRS Morningstar expects a substantial fall in payment rates resulting in an increasing focus on dealer and transaction liquidity sources and amount, while also heightening the possibility of transactions experiencing early amortisation events. Once a floorplan transaction enters the amortisation period (controlled or otherwise), repayment of principal is dependent on the ability to resell the inventory either through the retail channel or the auction process. In the current environment, any transactions in the accumulation period or that rapidly enter an early amortisation period face even greater risk as the ability to sell vehicles is severely restricted.
When assessing auto wholesale transactions, DBRS Morningstar considers certain risk factors including the financial strength of the manufacturer and finance company, exposure to dealer default and fraud, alongside transaction-specific structures, such as the legal framework and the corresponding cash flow analysis. These risk factors, in addition to vehicle valuation and remarketing channels, have all been negatively affected by the pandemic.
From a transaction cash flow perspective, in the immediate short term, a sudden drop in new vehicle sales will lead to a dealer’s greater reliance on payment streams arising from diversified sources such as spare parts and to a lesser extent, if eligible, sale of used vehicles. However, transaction concentration limits typically restrict these asset types considerably. Furthermore, we expect finance companies to offer deferrals of interest payments on outstanding inventory and extensions of required principal repayments in the form of curtailments and maturities, further reducing cash flow available to these transactions.
The suppressed cash flow places a greater focus on the structural liquidity coverage available to the transactions to make timely payments on the rated notes. Transactions rated by DBRS Morningstar address liquidity in various ways – all transactions have a dedicated liquidity reserve, some already discount principal collections to enhance available yield, while others allow for principal collections to be reclassified as income collections. The reliance on principal collections and the extent to which they provide liquidity coverage will be negatively affected by the interruption in vehicle sales, implying that the sizing of the dedicated liquidity reserve is key to determining a worst-case liquidity coverage. Liquidity reserves in DBRS Morningstar-rated transactions provide between three and 12 months of coverage assuming a full cash flow stoppage, with certain transactions more exposed than others because of the indexation of floating-rate liabilities and the absence of hedging structures to offset rate increases.
The scale of the impact on payment rates will vary by jurisdiction and will be primarily dependent on whether dealerships are permitted to remain open, easing of stay-at-home guidelines, travel restrictions, and their associated timing. Across Germany, France, and the UK, all dealerships have closed, with the exception of their parts and servicing departments, while in North America, some dealerships remain open for vehicle sales. Remarketing channels have also been affected as physical auctions have been suspended while online auctions remain active to varying extents. The impact on consumer behaviour is consistent with instructions to stay at home and to avoid nonessential travel.
Taking the March 2020 sales figures as an example and considering that restrictions were imposed at different times in each jurisdiction, we expect a significant decline in payment rates for April
2020 should restrictions remain. The extent of the decline will vary by jurisdiction, but it is possible that declines will be at least 50% compared with the expected range.
The sudden decline in payment rate exposes auto wholesale transactions to the risk of early amortisation events that track three-month average payment rates. Even with one month of very low activity, it is possible for a transaction trigger to be breached, although the variance between triggers and current performance varies considerably. For transactions that DBRS Morningstar rates, the payment rate triggers and the last reported values are shown in Table 1.
Payment Rate Trigger (3MA)
|Last Reported Value|
|Globaldrive UK Dealer Floorplan Funding I Limited||FCE Bank||18.0%||22.7%|
|FCT Cars Alliance DFP France||DIAC S.A.||25.0%||51.4%|
|Cars Alliance DFP Germany 2017||RCI Banque||25.0%||39.4%|
|FFAST 2017-F1||Ford Credit Canada
|GMF Floorplan Owner Revolving Trust Series 2013-A||GM Financial Company||17.5%||52.9%|
To avert an early amortisation of a transaction, sponsors may seek to implement waivers that look to omit the payment rate trigger over a limited time period while providing enhanced short-term liquidity. At this stage, we consider this to be sufficient in the short term to retain outstanding ratings on high investment-grade notes if a transaction has ample dedicated liquidity and subordination levels are maintained. However, the longer the current situation of dealership closures and measures of social distancing lasts, the greater the financial impact on the vehicle manufacturers, sponsors, and the dealer groups will be. This may directly affect the longer-term level of support made available by manufacturers to dealers while also contributing to the deterioration of dealer finances. In turn, this may lead to a greater reliance on and the availability of eligible sovereign support programmes.
The impact on vehicle values is yet to be seen; however, the restrictions on remarketing channels and the subsequently extended vehicle realisation timings will likely place downward pressure on vehicle prices. This could be compounded by increased stocks of used vehicle inventory because of rental car and lease/fleet returns. However, the suspension of new vehicle production may partially offset this as used vehicles may be purchased in lieu of new.
Based on our analysis to date, DBRS Morningstar has discovered that while the risk factors for dealer floorplan ABS are consistent across jurisdictions, ultimate ABS transaction performance is likely to be driven by a transaction’s unique structural features and other jurisdictional considerations, including the following:
- Credit enhancement step-up mechanisms driven by payment rate triggers differ across transactions;
- Different dealer concentration and overconcentration limits; and
- Amount of available liquidity to support timely interest on the ABS notes through reserve accounts varies across transactions, and the ability to redirect principal as
- Potential for online sales and parts and service department revenue to support transaction payment rates and dealers’ financial health;
- Impact and extent of various government support and stimulus efforts;
- Duration of stay-at-home restrictions and business closure rules; and
- Financial strength of the sponsor and ability to support the dealer base and ABS transaction
The coronavirus pandemic has rapidly disrupted normal business operations across the globe. However, given the potential for risk profiles to differ based on structural and jurisdictional considerations, it is quite possible there may be timing differences among jurisdictions with respect to any rating actions taken. DBRS Morningstar continues to monitor developments related to the pandemic and its impact on auto wholesale ABS transactions.
For further information regarding the impact on automotive manufacturers, please refer to: https://www.dbrsmorningstar.com/research/357864/the-impact-of-the-coronavirus-on-automotive- manufacturers.
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