Senior tranches of UK Auto ABS are expected to maintain relatively stable credit quality thanks to their available protection, but protection of mezzanine tranches could prove insufficient to offset a bearish scenario, Scope noted in a report out today.

Macro conditions will not be supportive. Weak UK growth will act as a drag on private consumption, which will weaken vehicle demand under a weak pound. Credit write-offs are expected to continue trending up given the pessimistic economic outlook, although tighter underwriting standards and lower risk appetite of financial institutions, are expected to mitigate any worsening in the situation beyond levels seen prior to 2012.

At the sector level, new car registrations in the UK decreased by 6.8% in 2018 while the new-car market could potentially dip by 10% this year in the event of no-deal Brexit, according to some estimates. The consumer confidence index, long correlated with second-hand car prices, dropped below 100 for the second consecutive month.

“Unlike captive transactions originated by car manufacturers’ financing arms, we expect the possibility of default in non-captive pools, originated by banks, to increase as macro risks mount,” said Iris Sie, senior analyst in the structured finance team of Scope Ratings and co-author of today’s report. “This is because non-captives generally position themselves in used-car finance and have riskier borrower profiles than captives. The perception of higher credit risk and less stable pool performance in non-captive transactions partly explains the higher offering spreads required in rated tranches relative to captives.”

Ninety-day-plus delinquency rates are trending up in non-captive transactions, while the performance of captive auto ABS remains strong amid Brexit uncertainty and a weaker macro situation in the UK. Scope expects the differences in delinquencies between captive and non-captive to widen in 2019, mainly due to the differences in risk appetite and market positions.

“Scope tested non-captive transactions by stressing an increase in the base-case default rate by 20%. The results show mezzanine tranches are exposed to 1-2 notches of adverse impact and no impact on senior tranches,” said Antonio Casado, co-author of today’s report and executive director in Scope’s structured finance team. “For captive transactions with predominantly optional balloon payments, mezzanine notes are exposed to one-notch sensitivity by stressing the decline in monthly vehicle market-value to accelerate by 10%.”

Download the full report here.