Squeezing the Brakes: Lenders Pull Back on Securitizations as Whole Loan Market Heats Up

While there may be only two issuers in the powersports asset-backed securitization space, the market is notably slowing as both companies have foregone issuing transactions this year.

But the pullback is not due to a lack of investor demand, Tom Baurle, managing director of investment banking and structured finance at Oak Ridge Financial, told Powersports Finance. “Good [investor] demand is still there,” Baurle said. “We are finding a lot more interested parties in the early-stage securitization financing that we do in powersports and in other markets than there were years ago. The market continues to be fairly robust.”

The Golden Valley, Minn.-based structured finance brokerage firm worked with ThunderRoad Financial Founder and Chief Executive Donal Hummer Jr. and his team on the powersport lender’s first-ever securitization back in April 2016.

The $59.7 million transaction — ThunderRoad Motorcycle Trust 2016-1 — was backed by prime and subprime motorcycle retail installment loans, according to a presale report from Morningstar Credit Ratings.

After adding its first securitization to the pipeline, ThunderRoad Financial became the second powersports lender to enter the ABS market after Harley-Davidson Financial Services — which typically issues a securitization at least once a year.

That is, until this year.

The captive’s previous securitization — a $302 million transaction backed by prime motorcycle loans — closed in June 2016. Harley-Davidson Financial Services has not yet issued a securitization in 2017.

Additionally, ThunderRoad Financial has delayed the issuance of its second securitization, which was initially planned for the first half of this year. Instead, the lender is focusing on other avenues of capital growth, such as whole loan sales, which is a market that is heating up and is “less fickle” than securitizations, Hummer told Powersports Finance.

Gauging Cost and Execution

In the secondary market, one of the easier and less expensive transactions are whole loan sales, Hummer said. “In relation to a securitization, it’s a pretty simplified loan sale transaction, and you can afford to break those down into smaller numbers,” he said. “You can do a $5 million, $10 million, or $100 million transaction, whereas with a securitization, you really should be looking at something on the order of $50 million or more — in reality $100 million or more, which makes it a lot more cost effective.”

In its infancy, ThunderRoad Financial issued whole loan sales, typically in the range of $5 million, Hummer said. In fact, ThunderRoad Financial completed its fourth whole loan sale to date in early October, this time of 5,000 accounts. This is the powersports lender’s second-largest transaction to date, at $55 million, after its $60 million asset-backed securitization, Hummer said. The backer of the purchase is a California-based alternative investment manager  that’s valued at $13 billion and focuses special situation investing.

“There seems to be a lot of interest in that right now,” Hummer said. “The capital markets are fickle … but you just have to be adaptable to the changing environment.”

Reno, Nev.-based ThunderRoad Financial makes loans for 450 dealers in 30 states, and is partnered with Royal Enfield North America. The lender had 5,717 loans in its portfolio as of January 2016, up from 1,510 loans in January 2015, according to a recent presale report.

Since powersports vehicles are not as popular as other conventional consumer products, and a lot of people view the vehicles as a luxury instead of a necessity, few players securitize, said Phoebe Xu, Morningstar’s senior vice president. “For those small players, why they are not securitizing might have to do with the cost of structure,” Xu said. “They may have other chief funding, so they may decide not to [securitize].”

The decision of which secondary market avenue to take for a specialty finance company like ThunderRoad Financial revolves around cost and execution, Oak Ridge’s Baurle said. “The question then becomes, ‘OK, does the cost of the securitization marry up with the better execution that securitization might provide?” he said. “Does that securitization bring into the market institutions and banks and whoever else that would not otherwise be in the whole loan market? The answer oftentimes is yes, sometimes it is no.”

Along with Hummer, Oak Ridge decided that based on ThunderRoad’s portfolio, a whole loan sale would offer better execution for the company this year, Baurle added. “But he has those options as he goes forward with us, and you weigh that every time you go to the market.”

One of the biggest obstacles when issuing a securitization is the startup cost, Hummer said, noting the regulatory and legal expenses — in addition to setup fees for a first-time securitization. “That being said, if done properly, the residual stream that you get at the end of this more than makes it worthwhile to do.”

Hummer declined to offer exactly how much capital the transaction freed up for the company, but in a June 2016 webinar he said the securitization “freed up a lot of cash for us to redeploy and prudently grow our business.” For most issuers, the first deal tends to be the most expensive, “because a lot of the templates and ground rules are set up in those first deals, and those are expenses that don’t get repeated on subsequent deals because there is already a template in progress,” Baurle said. “Those expenses, if you amortize them out over three to five deals, it kind of smooths that expense out.”

The cost is high, but if the issuers are committed to the market, it’s beneficial, Morningstar’s Xu said. “Once you have the processes in place … like for Harley-Davidson Financial Services, as one example, once you set up a securitization platform, it’s an ongoing process.”

Looking back, issuing a securitization was a “good thing” for ThunderRoad, Hummer said, particularly from the standpoint of gaining brand recognition and bolstering its growth strategy. “We will be looking to do [securitizations] again in the future, probably in the 2018 or 2019 timeframe, and in the $100 million-plus range,” he added.

The securitization process can cost a few hundred thousand dollars or more, which is why it could be better for smaller players to focus on whole loan sales, he said. In the meantime, that company can then look toward a larger securitization, which “spins off a lot more money for the same amount of expense,” he said, adding that this is a strategy ThunderRoad is currently pursuing.

Big Demand, Few Issuers

Part of the reason for the dearth of securitizers is there is a lack of comparative data from other lenders, Hummer said. However, some of the benefits of powersports ABS versus auto ABS include better margins for the same credit tier bands. “If you are looking at the risk profile of Fico scores and those kind of things, your powersports portfolio will generally have a stronger profile for the same or better coupon yield,” he added.

Motorcycles depreciate at a slower rate than automobiles, given that the vehicles are rarely the primary mode of transportation for most consumers, he said. “If you are looking at something to invest in, typically [a motorcycle] will depreciate less, have a stronger residual value, and it is going to do much stronger down the auction line than [an] automobile,” Hummer said.

Investor demand in the secondary market, for both ABS transactions and whole loan sales, is robust, said Chris Flannery, managing director of investment banking at Oak Ridge Financial. “The securitization market is a deep source of capital that generally provides attractive interest rates and terms for ThunderRoad and Harley-Davidson,” he said. “The other factor that is important, I know at ThunderRoad and I would guess to Harley-Davidson too, is the diversification of funding sources. ThunderRoad would rather not rely on just a bank or on just the securitization market; it’s good to have access to multiple lending markets for them.”

Relying on alternate sources of funding can be particularly beneficial in a market ripe with turnover. Chrome Capital, as one example, stopped accepting lease applications in September 2016 after a halt in investment funding from Leucadia National Corp.

On the other hand, many players in powersports finance are regulated institutions “with access to very, very cheap funds,” Hummer said. “If you are a bank and are using deposits to fund your consumer lending, there is probably not a lot of reason for you to securitize or do whole loan sales, because you are making such a huge spread on your yield because your cost of funds are so low.”

Harley’s Strategy Change

The financial services operating income at Harley-Davidson Financial Services was down 8.5% year over year in the second quarter due to the full securitization “gain on sale” during 2Q16, “which did not recur in the second quarter of 2017,” according to parent Harley-Davidson Inc.’s latest earnings.

There was also a notable change from the captive’s 2015-2 issuance — a $500 million transaction in April 2015 — according to presale reports. Trust 2016-A shows a “stronger mix” in its pool.

Last year’s $302 million securitization was backed by prime motorcycle loans, according to a presale report from Moody’s Investors Service. The loans in the trust showed an average Fico score of 751, up from 711 in HDFS’s 2015-2 issuance. “The 2016-A pool has no loans with a Fico score below 670, while almost 30% of the loans in the previous pools had Fico scores below 670,” Moody’s said in the report.

Also, the average original term decreased to 70 months in the 2016-A pool, the lowest original term since 2012. APRs in the 2016-A pool were capped at 11%, compared with 24.5% in the 2015-2 issuance. The 2016-A pool also had fewer used vehicles compared with previous transactions, according to the report. Used vehicles comprised 23% of the pool, down from between 33% and 39% in previous pools.

“The most recent transaction — the 16-A — they wanted to make a switch toward prime deals to begin with,” said Anna Burns, associate analyst at Moody’s. “Before that, the collateral was of a mixed quality; we had a lot more near-prime and even subprime borrowers in the pools.” Additionally, Harley-Davidson changed the name of its transactions, Burns said. Prior to the 2016-A pool, HDFS issuances were numbered, for example 2015-1, 2015-2, etc. “Here, they made a change toward letters, which indicated that they were changing the direction in which they were going,” Burns said. “They deliberately made it prime versus a near-prime pool.”

Harley-Davidson also switched to public securitizations from Rule 144(a) transactions, Mike Labuskes, vice president and senior analyst at Moody’s, told Powersports Finance. Rule 144(a) is a Securities and Exchange Commission rule modifying a two-year holding period requirement on privately placed securities.

“Public deals tend to have a broader investor base, but they are a little bit more expensive and a little more complicated to get done from issuer’s standpoint because of [the regulatory] hoops and hurdles they have to go through,” Labuskes explained. “There is additional followup to those hoops and hurdles they have to go through on an ongoing basis to keep that public standing.”

Traditionally, companies that issue more frequently and on a regular basis tend to go the public route, he said, and those that issue “fairly infrequently” tend to go the 144(a) route. However, it is unclear if the switch from public securitizations from 144(a) transactions had any effect on Harley-Davidson’s decision to forego a securitizion this year. A Harley-Davidson Inc. spokeswoman said the captive does not comment on its financing plans.

Regardless, the lack of an issuance this year is not necessarily a negative sign for the company, said Brian Grow, Morningstar’s managing director of asset-backed securities ratings and research.

“I think [not securitizing for a year] has to do with options and the current rates in the market, which fluctuate,” Grow said. “I don’t think it hurts to not securitize for a year. Once that [platform] is set up, they can evaluate when it’s best to go to the capital markets. … If it makes sense for the issuer to go to the capital markets, they will.”

Additionally, some issuers may decide to change the frequency of securitizing, said Morningstar Vice President Rohit Bharill. “It’s as simple as they don’t have as many loans to securitize, so instead of having a securitization in each half of the year, they may decide to stop and issue once in a year, or decide to only securitize once every two years.” However, new issuers may still trickle in. Investor demand is still high, Hummer said, adding that it would be surprising if there are not other powersports issuers that securitize in the coming year or two.

After the ThunderRoad Financial transaction, “the interesting thing that came out of that was the number of calls from issuers that were not only in the powersports space, but had similar business models with a varied form of different asset classes,” Oak Ridge’s Baurle said. “I will say at least half of them we turned down just because there wasn’t a path forward for them, but I think the market will become more liquid and … others may follow suit.”

This article originally appeared in the Powersports Finance third-quarter magazine issue. To view the full issue, click here.

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