NEW YORK -

Fitch Ratings spotted more ramifications associated with dealerships in connection with the inventory pinch of both new and used vehicles.

With rising sales and soft volume at auction and OEM factories, Fitch Ratings said on Monday that accelerated dealer auto inventory turnover has resulted in insufficient collateral available for dealer floorplan (DFP) asset-backed securities (ABS) master trusts in 2021.

Fitch Ratings indicated this development is indirectly accounted for by deal structures, for the most part, through the use of the excess funding accounts (EFAs). Analysts explained EFAs are meant to protect trusts against inventory volatility and help mitigate lower cash flows but can introduce negative carry risk if cash in EFAs increases to high levels and is relied on to make note payments.

The firm pointed out that EFA caps provide some protection against negative carry risk and vary by trust but most are limited to 30%. If exceeded, Fitch Ratings said there is usually a three-month cure period before an early amortization event is triggered and the trust would pay down the notes.

Fitch Ratings recapped that sponsors routinely add to or remove cash from EFAs to protect against changes in inventory volume by providing liquidity if there is not enough trust collateral for sufficient hard credit enhancement. Recently, analysts determined trust asset balances started to decline to historically low levels, and sponsors needed to address this by adding more cash to EFAs to cover for missing collateral and ensure adequate enhancement levels to support the notes.

Most of the time EFA account levels are close to 0% across the eight DFP ABS trusts rated by Fitch but ranged up to approximately 24% as of the May reporting date.

“However, relying on cash in the EFAs to pay note interest may itself result in negative carry and leave auto finance companies responsible for paying note interest,” analysts said.

“Fitch does not assume dealer lenders will make interest payments in its analysis but believes most lenders will be able to given their financial strength as reflected in the ratings,” they continued. “In the very remote event lenders do not make interest payments, this would cause an event of default, which may result in the notes becoming immediately due and payable.”

Fitch Ratings also mentioned the structural protections of robust credit enhancement, liquidity/credit enhancement triggers and backing from sponsors are supportive of current DFP ABS ratings.

“We expect issuers will have no difficulties paying down outstanding transactions when they mature, but we believe there will be lower new issuance volume until inventory levels return to pre-pandemic levels,” analysts said.

“Uncertainty remains as to how long these inventory shortages will last, although Fitch believes they will persist at least into 4Q21. Due to the relatively long lead-times needed to ramp up chip production, it could be a year or more before vehicle production and supply normalize,” they continued.

Fitch Ratings closed its update by noting that higher inventory turnover also is leading to “extraordinarily” high trust monthly payment rates, some at more than 100%.

“Continued robust retail sales, record-high new- and used-vehicle prices and low-interest rate costs are all boosting dealer net profits and margins despite the supply shortage, although this will dent sales volumes in 2021,” the firm said.

Fitch currently rates 21 series comprising of 44 tranches issued from six auto-DFP ABS trusts totaling $15.4 billion outstanding as of the April reporting date.