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Fitch: German Auto ABS Balloon Loan Exposure Has Risen
August 24, 2017 / 10:34 AM / 3 months ago

Fitch: German Auto ABS Balloon Loan Exposure Has Risen

(The following statement was released by the rating agency) DUBAI/LONDON, August 24 (Fitch) The German auto ABS market's exposure to balloon loans has risen in recent years reflecting their growth in the auto loan market as a whole, Fitch Ratings says. Balloon loans increase default risk because the borrower has to make a large payment when their contract matures. We take account of this in our transaction analysis. Fitch has reviewed loan-by-loan data from the European DataWarehouse for German ABS deals issued since end-2013. The average balloon loan exposure in new deals has risen to 39% in 2016 from 32% in 2014. Originators are increasingly offering balloon loans as they are more affordable in the run-up to maturity due to lower monthly repayments and to incentivise borrowers to buy another car at maturity, in Germany as elsewhere in Europe. Balloon exposure remains significantly higher in captive financing companies' portfolios than in non-captives (44% versus 20%), but the increase was slightly larger among non-captives. <iframe allowfullscreen src="//e.infogram.com/76cbc85c-ff96-4cd3-bdf1-a1accbd317b2?src=e mbed" title="Average Balloon Exposures in German Auto Loan ABS" width="550" height="646" scrolling="no" frameborder="0"> Higher balloon exposure implies higher default risk in portfolios as borrowers may face a payment shock if they are unable to refinance or lack access to a part exchange deal at the end of their loan contract. This situation would not arise in a fully-amortising loan with equal monthly payments throughout the contract life. Increased performance risk is driven by the higher proportion of balloon loans, rather than the balloon loans themselves becoming riskier, because the balloon amounts as a percentage of car values have remained stable or fallen slightly. In Germany, it is usually the borrower who is required to repay the balloon amount due at maturity (typically 20%-40% of the total loan). If they do not have money available to do so, they can refinance the balloon amount (with the originator or another finance provider) or hand the car to a dealer to be sold on. Sale proceeds, reflecting the then-current second-hand price of the vehicle, will be used for repayment of the balloon. If refinancing is unavailable, or the gap between the balloon amount and the sale price is too large, the borrower may default on the outstanding final balloon amount. Whether the use of balloon loans in Germany will continue to grow will depend on factors such as originators' risk appetite and used car prices. We do not expect the recent increase to reverse, and indirect residual value risk may become more relevant to our auto ABS analysis as originators begin to use balloon loans to finance more used car sales, where residual values can be more volatile and harder to forecast. If a vehicle is repossessed, balloon contracts can reduce achievable recovery proceeds due to slower amortisation increasing the gap between the car value and the outstanding loan amount, compared to a fully amortising loan. A benign macro-economic backdrop means that recent performance data does not reflect additional risk from large final instalments. But borrowers' ability to repay or refinance balloon amounts would be impaired in more stressful times. Fitch will monitor balloon loan exposure in its transaction analyses and adjust our stress assumptions to account for the balloon risk within our default multiples. We will also continue to review shifts in originators' risk appetite with respect to balloon-setting. Other risk factors, such as original loan terms, LTV ratios, and affordability measures, have remained broadly stable for most German originators. Coupled with the current macroeconomic backdrop and originators' efforts to improve servicing procedures, this has supported strong performance in Fitch-rated German deals. Shifts towards higher risk characteristics in an originator's overall loan book, or deviations between their total book and transaction portfolios, will be reflected in our base case performance expectations. Contact: Thomas Krug Associate Director, Structured Finance +49 69 768076 252 Fitch Deutschland GmbH Neue Mainzer Strasse 46-50 60311 Frankfurt am Main Michael Ecke Analyst, Structured Finance +49 69 768076 139 Eberhard Hackel Senior Director, Structured Finance +49 69 768076 117 Mark Brown Senior Analyst, Fitch Wire +44 203 530 1588 Media Relations: Athos Larkou, London, Tel: +44 203 530 1549, Email: athos.larkou@fitchratings.com; Adrian Simpson, London, Tel: +44 203 530 1010, Email: adrian.simpson@fitchratings.com. The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings. 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