KBRA cautions finance companies about misuse of contract modifications


In a separate letter where the firm’s president and chief executive officer acknowledged, “the news will not always be positive,” Kroll Bond Rating Agency (KBRA) compiled a lengthy report this week, examining the potential long-term ramifications of finance companies making contract modifications with their customers because of COVID-19.

While analysts applauded the modification efforts finance companies are utilizing, KBRA also cautioned the auto-finance industry that “if used incorrectly, modifications simply delay the inevitable.”

Analysts said in the report, “In general, we believe loan modifications are an important loss mitigation tool for loan servicers and, when used appropriately, ultimately benefit borrowers and ABS investors. From a positive perspective, they can reduce default rates and maximize long-term cash flow.

“On the other hand, deferrals may delay or reduce short-term cash flow, avoid trigger breaches, delay recognition of losses and dilute overcollateralization,” they added.

KBRA explained that April asset level disclosures showed that early-stage delinquency rates were relatively stable across securitized auto finance pools in March. Analysts contend that the relative month-over-month stability in delinquency rates was likely driven by payment timing, “as we believe most borrowers made their March loan payments prior to the first U.S. states issuing statewide stay-at-home orders, beginning with California on March 19 and, to a lesser extent, loan servicers granting loan modifications for those paying later in the month.”

Meanwhile, KBRA discovered May’s asset-level disclosures — which reflect collections in April and the first full month of pandemic-related stress — showed that early-stage delinquencies fell sharply month-over-month for each of the 21 auto finance issuers that provide asset-level disclosures to KBRA.

The firm added most of those issuers also reported a year-over-year decline.

“At first glance, the month-over-month and year-over-year decline in early-stage delinquencies posted in April seems extraordinary against the backdrop of the unemployment rate skyrocketing to a previous unimaginable 14.7% during the month,” KBRA said in the report.

“Enhanced unemployment benefits and federal stimulus checks likely played some part in lowering delinquency rates in April, as we believe the majority of securitized auto loan borrowers were eligible for at least some level of stimulus,” analysts continued. “However, we think the large percentage of borrowers receiving loan modifications during the month was the main driver.

By the end of April, KBRA determined the percentage of consumers with an actively modified contract ranged from 2.0% to 12.1% for securitized prime auto pools and 7.1% to 21.3% for non-prime pools, up significantly from prior months.

“Based on our discussions with issuers, we believe borrower modification requests began to level off in April. However, given that most issuers provided borrowers with two to four months of payment relief, we expect portfolio modification rates to remain elevated into the summer months,” analysts said.

“To reiterate, we believe that loan modifications can be a helpful tool for reducing delinquency and default rates, as it allows borrowers to manage a period of short-term financial difficulty. However, if used incorrectly, modifications simply delay the inevitable, pushing out losses and increasing tail risk to a securitization,” analysts went on to say.

KBRA supported its assertions by pointing out that approximately 95% and 80% of customers in prime and non-prime pools, respectively, who received a contract modifications in April were one to 29 days past due on their monthly payment.

“This suggests that lenders are not managing the timing of losses by giving already serious delinquent borrowers a loan extension,” analysts said.

Letter from KBRA’s president and CEO

Meanwhile, a day after releasing that auto-finance report, KBRA president & CEO James Nadler sent a letter to its industry customers. The body of the message is published here:

To our valued customers:

On behalf of the entire KBRA global organization, I would like to extend our heartfelt thoughts to anyone who has been personally affected by this unprecedented virus and civil unrest. As countries around the world collectively move toward brighter and more stable times, we must keep alive the memories of those who succumbed to the virus, even as we comfort our family and neighbors, and honor the everyday heroes who are helping in the recovery.

KBRA started 10 years ago this summer in the aftermath of the great financial crisis that was building over many years. Our founding principle was a simple promise to investors: provide the market with timely, valuable, and transparent research and ratings. Your response over the interim years has been humbling as not only have you accepted our core values —innovation, collaboration, and integrity to drive forward-looking market research and credit ratings—but your belief in our mission has helped our company become the world’s largest post-crisis rating agency.

Our commitment to you is equally as strong and we view your trust as our primary responsibility. As the world has awakened to turmoil and uncertainty, KBRA has worked diligently to produce investor research that looked beyond the headlines. We are proud to say that our countless outreach calls and engagement with market participants across the entire spectrum of our rating universe has led to the publication of more COVID-19 impact research than any of our competitors. And rest assured that our commitment to you will not end when the crisis is over. We will always provide you with the research and analysis you need to understand the markets during stressful times and good times.

The news will not always be positive. We are in the middle of an unprecedented crisis and some credit trends continue to deteriorate. We believe rating actions that are ill-timed or too broad can be misleading; timing and transparency are critical. At KBRA, all of our rating actions include a thorough and robust explanation backed by experienced analyst teams.

If one positive thing can come out of this crisis, it is that we have broadened and deepened our relationships with all of our valued clients. As we look to the future — one that may look very different — we promise to maintain our renewed and deeper relationships, along with providing you the best that KBRA has to offer.

Again, I thank you for your support over the last decade and look forward to building stronger relationships over the many decades to come.

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