NEW YORK — After a nearly two-year hiatus following the
credit crisis that began in late 2007, Standard & Poor's Ratings Services insisted
the issuance of subprime auto loan asset-backed securities has rebounded
significantly.

In their latest report, analysts highlighted the wave of
growth since 2010 has come hand-in-hand with a relaxation in lending standards
as the more established originators increase their loan volumes to prior levels
and newer entrants seek to make inroads.

"Though competition has heated up and we've noticed some
degradation in credit quality, the degree of credit loosening hasn't had a
significant impact on the performance of most issuers' pools, and so far most
deals continue to perform in line with, or better than, our initial
expectations," said the firm's structured finance ratings team led by senior
director Amy Martin.

"For issuers that have shown better credit performance than
we had originally expected, the credit enhancement for their newer transactions
has declined," Martin and the team continued. "For others that have been seeing
increasing losses, credit enhancement on their recent transactions has risen
accordingly."

S&P determined the higher credit enhancement levels for
certain transactions, as well as the deals' sequential payment structures
(whereby the full repayment of higher-rated classes of notes precedes the
repayment of the more junior classes), continue to insulate subprime auto loan
ABS transactions from rating downgrades.

In fact, Standard & Poor's has not lowered a subprime
auto loan ABS rating for credit-related reasons since 2002 (when a
confidentially placed subordinated security, originally rated 'BB (sf)' in
1997, defaulted).

"We expect this trend of general rating stability to
continue," analysts said.

During the past seven years, S&P described the
competitive landscape in subprime auto lending as coming nearly full circle. Analysts
contend lending grew and became more aggressive between 2006 and early 2008,
with credit to this sector flowing freely.

Further, S&P believes some of the big U.S. automakers'
domestic captive finance entities began making loans to consumers with
subprime-type credit scores (less than 620) as they looked to unload mounting
levels of inventory.

As a result of increased competition, Martin and the team
explained acquisition fees (also referred to as "discounts") and annual
percentage rates (APRs) declined for subprime auto loans. They also noted lenders
tried to compensate by increasing loan volumes, which they were able to do by
lowering credit standards, such as by offering higher loan-to-value ratios (LTVs)
and longer loan terms such as 72 months.

"From late 2008 through 2010, through the credit crisis and
recession, many originators curtailed lending by severely tightening their
credit standards, while others temporarily stopped originating, and some even
went out of business," analysts said.

"As a result, lending volumes and subprime auto loan
asset-backed securitization (ABS) issuance fell to nearly nothing in 2008 and
2009," they continued.

"Liquidity and capital have since returned to this sector,
however, making it much easier for auto finance companies to fund their loan
originations," Martin and the other analysts went on to say. "And the rise in
originations has come not only from the already established players, but also
from a new crop of subprime auto finance companies, many of which emerged to
fill the void created during the credit crisis.

"The rise in subprime loan volumes has, in turn, helped fuel
the recent growth in auto loan-backed securitizations," they added.

Signs of Weakening Credit Standards Are Emerging

In the firm's view, the most prominent indication that
credit standards have weakened is the rise in weighted average LTV ratios.

In aggregate, Standard & Poor's determined the weighted
average LTV on its rated subprime auto loan ABS pools has increased steadily to
113 percent in 2012 and 114.5 percent year to date, from a low of approximately
112 percent in 2010 and 2011.

The firm pointed out this increase in LTVs came despite a
rise in the value of used vehicles to historical highs, "which, all else being
equal, would drive down the LTV ratio," according to analysts.

S&P mentioned the annual average value of the Manheim
Used Vehicle Index climbed to 123.6 in 2012 and has remained above 120 to date
in 2013, compared with 112.1 in 2009.

While the average LTV is still below the peak of 121 percent
in 2008, it continues to inch up as lenders look to expand originations, according
to S&P.

In contrast, the firm noted LTVs for prime lenders have
fallen to 94.5 percent last year and 96.4 percent year to date from above 100
percent in 2007. Analysts said this trend came about "in part because greater
liquidity in the market has allowed them to focus on the most creditworthy
clients.

"Higher LTV ratios are a credit concern because higher loan
advance rates generally lead to lower recovery values upon repossession of a vehicle
if an obligor defaults," Martin and the team continued.

"Also, larger advances themselves may lead to a higher
default frequency: If an obligor owes more on the loan than the vehicle is
worth, it reduces the incentive to remain current on the obligation," they went
on to say. "Higher LTV ratios also generally indicate a lower down payment,
which may also limit the borrower's incentive to make loan payments when
experiencing financial hardship."

Standard & Poor's reported that it's also seeing longer
loan terms for the subprime auto loan segment. The firm contends the 72-month
loan term has become the norm, replacing the 60-month term for the largest
subprime lenders.

While the percentage of loans with original terms of 61 to 72
months has consistently exceeded 70 percent of Standard & Poor's rated
transactions since 2008. This level is up from 48 percent in 2004.

While the 72-month loan term is the most popular term in
prime lending as well, S&P explained the percentage of these loans in prime
securitizations (approximately 45 percent) is lower than in subprime pools
(approximately 80 percent). This is because many prime lenders exclude longer
term loans from their pools in order to maintain consistency across their
pools. Also, many prime originators, including banks and captives, have diverse
funding sources and, as a result, often finance loans with higher perceived
risk outside of the securitization market.

In contrast, analysts insisted subprime lenders are
generally more dependent on the securitization market, so their pools more
closely mirror their overall mix of business. They said this explains why prime
pools continue to have a lower percentage of long-term loans than subprime
pools.

"The loans underlying most subprime auto ABS transactions
that we rate have had a maximum original term of 72 months, and many deep
subprime lenders that specialize in older vehicles with higher mileage have maximum
terms of 36 to 60 months," Martin and the team said.

"However, even some of these specialized lenders are finding
that they need to extend their terms slightly. Those that had terms of 36 to 42
months are lengthening them to 48 months, and those that had terms of 48 months
are extending the maximum term to 60 months to remain competitive and to keep
monthly payments affordable, given the rising cost of old-model used vehicles,"
they continued.

Also, S&P has recently noticed the inclusion of loans
with original terms of 73 to 75 months in some large subprime pools, and the
inclusion of loans with an original term of up to 84 months in nonprime pools
(those that have cumulative net losses of 3.1 percent to 7.5 percent).

When examining long-term loans (those with 61- to 72-month
or 73-plus month terms), we look at the other attributes of these loans,
including the weighted average FICO and LTV, to gauge the level of additional
risk," analysts said.

"When the other attributes appear weaker than those for the
overall pool, we generally conclude that lenders are making these longer-term
loans to higher-credit-risk consumers, and we adjust our expected cumulative
net losses accordingly," they continued.

FICO Score Analysis and More

Standard & Poor's determined the weighted average FICO
in subprime auto ABS pools has also weakened a bit in part because of the
acceleration in ABS issuance among deep subprime lenders.

Also according to the firm, some of the large, established
players have resumed normal lending standards as a return to sub-600 FICO scores
shows.

"FICO scores, however, aren't always the best indicator of
credit quality in this sector," S&P said. "Many lenders use proprietary
scoring models that are often better predictors of credit quality than FICOs.

"As an example, we've found that the percentage of loans in
the lowest-quality credit tier can have a disproportionate impact on the
overall losses of a pool," the firm continued. "These lower-quality loan tiers
have been growing recently, and the result has been softness in the overall
proprietary scores on some pools.

"The payment-to-income ratio is also a strong predictor of
credit quality in this segment, and we've noticed a general upward trend in
this statistic," analysts went on to say.

Standard & Poor's mentioned another indicator of how
competitive the subprime auto loan market has become is the decrease in
discounts or fees that the finance companies are netting from the price paid to
the dealers to purchase loans.

"Not only are finance companies paying a higher purchase
price for the contracts, but many lenders are paying ‘rate participation' to
the dealers to capture a greater share of the dealers' loan volume," analysts
said.

To clarify, S&P explained rate participation is the
portion of the interest rate charged to the obligor, which is above the finance
company's offered interest rate, paid to the dealer as compensation for its
administrative work associated with preparing the loan application.

"During the credit crisis and through the first half of
2010, competition was sparse, and subprime finance companies were able to
charge higher discounts and forego paying rate participation," analysts said.

Despite Several Factors, Ratings Should Remain Stable

In wrapping up its latest report, S&P projected that it's
expecting continued weakening in credit standards as more players vie for a
piece of the subprime auto loan market and others try to hold on to market
share.

"We incorporate this into our new-deal rating process by
analyzing issuers' recent loan performance and changes in the collateral and
obligor characteristics of their pools. We then make adjustments to our
cumulative net loss proxy as we deem necessary. When these loss ranges
increase, hard credit enhancement levels often rise, particularly if excess
spread has remained unchanged or has declined," Martin and the team explained.

"In fact, as funding spreads have widened in recent months,
in anticipation of the Federal Reserve adopting a less-accommodating monetary
policy, excess spread has declined measurably in some transactions, and this
has necessitated an increase in hard credit enhancement for some issuers," they
continued.

"At this time, we anticipate that ratings on subprime auto
loan ABS will remain generally stable for the rest of the year, with upgrades
far surpassing downgrades," Martin and the team went on to say.

"While lower recovery values on used vehicles and the modest
degradation in credit standards could cause losses to rise, we believe the
deleveraging of the transactions through their sequential-pay structure will
mitigate these risks, particularly for the investment-grade bonds (those rated
'BBB-' or higher)," they concluded.

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