abs outlook 2013
TRANSCRIPT
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8/9/2019 Abs Outlook 2013
1/15
US Fixed Income StrategyUS Fixed Income Markets 2013 Outlook
November 21, 2012
Amy Sze, CFAAC
(1-212) 270-0030
Kaustub Samant (1-212) 834-5444
J.P. Morgan Securities LLC
1
Playing the ABS market in2013: One game at a time
We maintain our bullish outlook on ABS into2013 given exceptionally strong technicals andsolid fundamentals
External headwinds such as regulation, the USfiscal cliff, European sovereign risks, andgeopolitical conflicts persist. However, QE3-driven technicals against the backdrop of sloweconomic growth (despite the drags) should
ultimately push ABS spreads tighter We recommend investors to add ABS on
weakness throughout 1H13. Headline or supply-induced technical blips will most likely turn outto be temporary
We project 2013 ABS supply of $205-215bn,compared to $187bn YTD 2012. Increased issuanceis expected in the credit card and auto sectors
We estimate a tiny net increase of $5bn inoutstanding ABS, the first increase after fiveconsecutive years of contractions
With the economy still on track in this long andpainfully slow recovery, consumer health remainssound. This should translate into stable loss anddelinquency trends for ABS credit performance.ABS structures and seller/servicers shouldperform well within expectations
The charge-off rate on our bankcard ABS mastertrust index should stay in the 3-3.5% range nextyear, near historical lows
Auto ABS speeds will likely continue to inch upon higher auto sales, while student loan ABSspeeds remain slow due to limited refinancing
opportunity and high unemployment Negative rating volatility should continue to
decline in 2013 for ABS with stable creditperformance and generally more stable outlooksfor ABS sellers/servicers and counterparties,except for FFELP ABS ratings due to thenegative outlook on the AAA US sovereign rating
Many regulatory rules remain unclear and/orunfinished as the ABS market heads into 2013.
We remain cautiously optimistic that there will be
no insurmountable regulatory hurdles thatdisrupt the flow of liquidity to ABS issuers andconsumers
We believe ABS spreads can set new post-2007tights in 2013, but it will likely be a shaky startwith the fiscal cliff looming right around the startof the year
ABS will continue to provide a safe haven toinvestors concerned about the fiscal cliff and inneed of higher-yielding Treasury surrogates
We expect 3-year AAA bankcard ABS spreads toreach swaps +5bp by mid-2013 and swaps flat by
year-end 2013
Our top choice in AAA ABS is short front-payprivate credit student loans; for more yield, werecommend going down in credit to subordinatesubprime auto ABS
2013 ABS out look: The endurance game
Looking ahead to 2013, we expect the ABS market to
continue to endure the regime of low yields, supply
shortage, and lackluster economic growth, combined
with the persistent headwinds of US and European
sovereign risks and other geopolitical fires. We remainbullish on ABS spreads due to positive technicals and
credit fundamentals. In terms of technicals, QE3
continues to be the tide that lifts all boats, as Fed
purchases of agency MBS and low interest rates will
continue to leave investors hungry for credit products and
starved for yield. We expect ABS issuance activity in
2013 to increase by 10% y/y to $205-215bn. The
established ABS investor base has demonstrated a
stronger appetite for more paper in recent years, and
liquidity has completely recovered from the subprime
RMBS meltdown; at the same time, ABS (and aggregate
securitized products) supply, even with the projected
growth, is far from where it was in the heyday. Weexpect investors to continue having difficulty sourcing
bonds.
On credit fundamentals, three years after the official end
of the recession, we are still on the anticipated long road
of recovery. We knew that it would be a long climb out
of a deep trough on every front, including housing,
consumer deleveraging, and the labor market. 2012 saw
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8/9/2019 Abs Outlook 2013
2/15
US Fixed Income StrategyUS Fixed Income Markets 2013 Outlook
November 21, 2012
Amy Sze, CFAAC
(1-212) 270-0030
Kaustub Samant (1-212) 834-5444
J.P. Morgan Securities LLC
2
moves in the right direction, and 2013 should bring more
positive, but once again small, steps forward. In 2012,home prices bottomed, consumers showed signs of
increased demand for credit (e.g., on auto loans, credit
cards, and student loans), and payrolls continued to make
steady gains. Growth in consumer credit and the ABS
market will reflect growth in the broad US economy,
which will remain painfully slow for most of 2013. JP
Morgan economists forecast real y/y GDP growth of
2.2% in 2012 and 1.7% in 2013. The unemployment rate
will remain well above 7.5% for the foreseeable future
into 2014. ABS credit performance has been quite
healthy amid this tepid recovery, supported by improved
underwriting, servicing, and structural enhancements.
We expect this positive performance to continue in theyear ahead given that slow growth is still growth. We
also believe that the credit quality of ABS pools should
remain stable, as sponsors remain relatively conservative
in credit underwriting and ABS structuring. In addition,
ABS sponsors remain in good financial health. Bank
ratings in particular should be more stable in the year
ahead. In 2013, the primary risks in the ABS market will
stem from exogenous factors rather than from credit
performance.
The downside risks to the ABS market in 2013 remain
external as they have been over the past two years. The
ABS market remains under constant regulatory scrutinyand unintended consequences may arise. However, we
remain optimistic and do not foresee any insurmountable
hurdles in the year ahead. We believe regulators will
continue to work with ABS market participants to ensure
the uninterrupted flow of liquidity and credit to
consumers.
In addition, the same headwinds, namely the US fiscal
cliff, the European sovereign debt crisis, and geopolitical
(Mideast) conflicts continue to buffet the financial
markets. The ABS market, along with the rest of the
financial markets, will likely be tested early in the year
by the fiscal showdown in Washington, DC. However,
the impact on the ABS market has become more muted
with each run of negative headlines. We expect this to be
the case in 2013 as well. As long as the US economy
does not plummet off the fiscal cliff (which is JP
Morgans base-case scenario, where our economists call
for real GDP growth next year despite anticipated fiscal
drags), ABS market fundamentals remain on solid
ground. In addition, we would say that current ABS
structures and credit enhancements would stand up to a
mild recession with minimal, if any, wear, but ABS
spreads, along with investor confidence, may well
weaken significantly under that low-probability stress
scenario.
Finally, given the strong technical dynamic and stable
fundamentals, we believe ABS spreads can set new post-
2007 tights in the year ahead (Exhibit 1). We project
AAA benchmark bankcard ABS spreads to lead the way
for the ABS market and reach swaps flat in 2H13. Credit
curves should also flatten further once the market movespast the fiscal cliff and economic growth picks up. In
addition, although absolute ABS spread levels have
narrowed notably this year, relative to all-time tights
(including before the 2007 financial crisis), there is
plenty of room for further tightening. Compared to 2007
and earlier structures, the newer crop of ABS has
undergone major enhancements to structure, credit
quality, underwriting, and servicing. Conditions will
likely be more shaky and volatile in 1H13, with the fiscal
cliff looming, but the tightening trends should solidify
thereafter. We would add on weakness throughout 1H13
during technicals blips and headlines that will very likely
turn out to be temporary.
Exhibit 1: 2013 ABS spread targets: tighterbp
*Subprime auto loan ABS spread history goes to 2010 only and do not cover pre-crisishistorySource: J.P. Morgan
Current
11/19/12 Wide Tight Spread Date 1H13 2H1
AAA
Credit Card 3-year, Swaps 10 14 7 -7 Sep-06 5 0
Prime Auto Loan 3-year, Swaps 18 30 10 -2 Sep-06 8 5
Subprime Auto Loan 2-year, Swaps 26 70 26 26* Nov-12 25 20
FFELP 3-year, LIBOR 20 55 20 -1 Sep-06 20 15
Private Credit 3-year, LIBOR 125 235 125 1 Jan-07 110 85
US$ UK RMBS 3-year, LIBOR 50 160 50 3 Nov-06 45 35
Subordinates, BBB
Credit Card 3-year, Swaps 65 130 65 23 Feb-07 55 45
Prime Auto Loan 3-year, Swaps 165 200 140 42 Jun-12 120 95
Subprime Auto Loan 3-year, Swaps 180 350 180 180* Nov-12 160 135
2012 All-time Tight Target
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8/9/2019 Abs Outlook 2013
3/15
US Fixed Income StrategyUS Fixed Income Markets 2013 Outlook
November 21, 2012
Amy Sze, CFAAC
(1-212) 270-0030
Kaustub Samant (1-212) 834-5444
J.P. Morgan Securities LLC
3
ABS supply/demand forecasts: Thehunger games
Net supply to venture into positive territory
After a cumulative decline of approximately $250bn in
outstandings over five consecutive years of contractions,
including a decrease of roughly $15bn in 2012, we
expect the ABS market in 2013 to finally edge intopositive net supply (i.e., new issuance minus maturities),
driven by growing supply from the auto and credit card
sectors (Exhibit 2). We project gains in the auto and
credit card ABS sectors, +$15bn and +$5-10bn,
respectively, to be partially offset by continued declines
in student loan and other asset classes, -$5bn and -$10bn,
respectively. Despite the likely small increases, volumes
in auto and credit card ABS are far off their peaks: auto
paper stands at $137bn compared to $197bn in 2006 and
credit card ABS at $160bn compared to $325bn in 2007
(Exhibit 3). We believe demand will remain higher than
the supply available in 2013 in ABS and across the
securitized product market, particularly due to QE3.
That, combined with low rates, will keep investors
hungry for credit products, particularly those that offer
incremental spread pickup.
New issuance continues to grow
Our gross ABS supply forecast for 2013 is $205-215bn,
with growth coming from the auto and credit card sectors
(Exhibit 4). We expect auto ABS supply to reach $95-100bn in 2013 versus $81bn YTD. This is consistent
with auto sales projected to increase to over 15mn saar
next year, along with greater consumer demand for auto
loans. In addition, auto lenders have more actively
sought funding in the securitization market. For
example, the number of subprime auto ABS shelves has
roughly doubled this year versus a couple of years ago.
On the prime side, we have also seen more issuers as
Exhibit 2: Tiny increase in y/y net ABS supply for 2013y/y change in amount outstanding ($bn)
Source: J.P. Morgan forecasts, BloombergExhibit 3: ABS amount outstanding still si gnificantlylower than the peaks$bn
Source: Bloomberg
Exhibit 4: ABS issuance volume to grow in 2013$bn
Note: 2012 YTD as of November 16Source: JP Morgan estimates/forecasts, IFR, Bloomberg
15
-5
5
-10
-90-75-60-45-30-15
015304560
2007 2008 2009 2010 2011 Nov 12 Proj2013
Auto Student Loan Card Other
0
50
100
150
200
250
300
350
400
2006 2007 2008 2009 2010 2011 Nov 12
Auto Student Loan Card Other
2009 2010 2011 2012 YTD
Projected
2013
Credit Cards 47 7 14 37.3 45
Bank/Charge 32 5 11 29.8 37
Retail 15 3 3 7.4 8
Autos 56 54 58 81.2 95
Prime Loan 38 32 28 45.1 53
Subprime Loan 3 9 13 16.8 21
Lease 8 8 12 12.6 15
Fleet 5 3 4 5.6 5
Motorcycle/Truck 2 2 1 1.2 1
Student Loans 19 19 15 22.5 25
FFELP 10 13 13 18.3 19
Private Credit 9.0 6 2 4.2 6
Equipment 7 5 7 11.1 12
Global RMBS - 7 26 8.8 3
Other 11 15 15 26.1 25
Floorplan 4 7 8 12.7 10
Miscellaneous 7 8 8 13.4 15
Total ABS 140 106 136 187.0 205
% 144A 41% 47% 42% 34%
% Floating-rate 45% 36% 45% 30%
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8/9/2019 Abs Outlook 2013
4/15
US Fixed Income StrategyUS Fixed Income Markets 2013 Outlook
November 21, 2012
Amy Sze, CFAAC
(1-212) 270-0030
Kaustub Samant (1-212) 834-5444
J.P. Morgan Securities LLC
4
well as more lease ABS programs. Separately, we have
seen a couple of bank issuers of prime auto ABS sell theresiduals for favorable off-balance sheet accounting
treatment. We expect the banks to continue pursuing this
strategy as long as ABS market conditions are favorable
and relatively insulated from negative external
headwinds.
In the credit card sector, our 2013 forecast calls for $45-
50bn in supply. We estimated close to $40bn in runoff
next year, which results in our net supply projection of
+$5-10bn. In comparison, YTD credit card ABS supply
totaled $37bn versus roughly $65bn in runoff this year.
We expect that cross-border activity in credit card ABS
to remain robust in 2013, with Canadian USD issuers
stepping up to offset lower UK issuer participation.
Securitization also remains an attractive funding option
for domestic banks looking for low-cost term funding.
We still think it makes sense for more issuers to
reactivate some dormant master trusts, even if its just to
maintain some presence in the securitization market
rather than for capital reasons. Finally, with ABS
spreads tightening, more subordinate issuance is possible.
All these factors should help revive credit card ABS
supply.
Supply in the student loan sector should stay relatively
flat next year versus this; we expect $25bn in 2013
versus $23bn YTD. There is a pipeline of FFELPreceivables from lenders balance sheets and conduit
funding programs to the ABS market, as well as
restructuring opportunities (albeit 2013 may well be the
end of the line). We expect FFELP student loan ABS
supply in 2013 to be flat to slightly down from this year.
We think the risk of a US sovereign rating downgrade by
another rating agency (in addition to S&P) will result in
only minor hiccups for FFELP ABS issuance, as spreads
have rallied notably and deals have been done with split
ratings on senior tranches. On the private credit side, we
expect very slow growth in underlying loan originations
and thereby securitization volume, due to the crowding
out of the private market by the governments FDLP
program.
In the global RMBS sector, we expect a sharp decline in
cross-border USD issuance from UK banks due to the
availability of a cheaper alternative from the Bank of
England and HM Treasury-sponsored Funding for
Lending Scheme (FLS). We project $3bn in sector
supply next year versus close to $9bn this year. In 2013,
the primary motivation for issuing in this sector is going
to be the desire to maintain a presence in the US ABSmarket, rather than funding need or cost.
Floorplan ABS supply could decline slightly next year
after posting $12.7bn this year. Refinancing needs will
decrease in 2013 with roughly $6bn, half of this years
runoff. The equipment ABS sector should continue to
see growth in 2013 to $12bn, after recording just over
$10bn in supply this year and $7bn in 2011. There is a
healthy list of diverse issuers in the large- and small-
ticket segments to support issuance activity. In addition,
business spending should improve with economic
growth.
Investor base to remain healthy
Liquidity in the ABS market has been excellent, with a
mature and established investor base. With the shortage
in credits, the ABS asset classes have now been well
explored by the influx of new investors, as well as
accounts branching out to different asset classes.
Looking ahead to 2013, the investor base for ABS has
limited growth potential, but the level of interest remains
higher than the supply available. We believe the supply
shortage could be particularly acute if there is any flight
to quality associated with the looming fiscal cliff.
Concerns over US sovereign risk will further underscore
the benefits of benchmark AAA ABS as cash surrogates.Top-tier AAA ABS offering spread pickup to Treasuries
could potentially attract even a few more corporate cross-
over buyers in the year ahead.
The overall sentiment in ABS investors 2013 outlook on
supply and spreads is positive. Our investor survey,
conducted over the week of November 12, drew a wide
range of respondents (45% of asset managers, 20% bank
portfolios, 15% insurance companies, and the rest spread
over hedge funds, pension funds, and non-US investors).
One-third of respondents expect issuance to increase by
5%, while another third project a 10% increase. In
addition, 13% of investors surveyed reported a bullish
15% increase versus 11% of investors expecting ABS
issuance to remain flat. Only 4.5% of investors expect
ABS issuance to decrease. We also asked investors to
project benchmark ABS spreads at the end of 1H13: 45%
think spreads will range 5-10bp and 32% think spreads
will range 0-5bp. Approximately, 6% of investors
project benchmark ABS to trade through swaps. One-
third of those who expect supply to increase by 10%
project benchmark spreads to widen out to 10-15bp.
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8/9/2019 Abs Outlook 2013
5/15
US Fixed Income StrategyUS Fixed Income Markets 2013 Outlook
November 21, 2012
Amy Sze, CFAAC
(1-212) 270-0030
Kaustub Samant (1-212) 834-5444
J.P. Morgan Securities LLC
5
However, those that think supply will increase by an
even larger 15% expect spreads to either remain range-bound or tighten. This suggests that investors expect
higher supply to be readily absorbed by the market.
ABS credit performance out look: A
clean game
We expect credit performance of consumer ABS pools to
remain healthy in 2013. JP Morgan economists expect
the US consumer and the private sector to be resilient in
the face of a sizable fiscal drag (particularly in 1H13).
Our economists expect the national unemployment rate
to continue trending downwards from 8.0% in 1Q13 to
7.8% in 4Q13 and real GPD growth to increase from
1.0% in 1Q13 to 3.0% is 4Q13. While the labor market
is still soft as measured by the high unemployment rate,
other metrics such as low labor costs, recent gains in
payrolls, low initial jobless claims, and improving
consumer confidence show that there is room for
improvement in the year ahead. In addition, signs of a
recovery in housing are emerging. Our non-agency
RMBS strategists expect home prices to rise 3.5% y/y in
2013 on a nationwide basis (Case-Shiller). The auto
sales recovery has been quite robust, averaging 14.4mn
saar this year, and JP Morgan projects it to climb steadily
to 15.2mn saar by 4Q13. Finally, we expect ABS pools
to remain clean in the year ahead, given that ABSsponsors are still wary of the domestic fiscal cliff and
European sovereign headwinds. Therefore, ABS
sponsors are unlikely to be pursuing aggressive
origination strategies that may turn off investors and
rating agencies. In our opinion, delinquencies and losses
on consumer ABS pools will likely remain low at current
levels in the year ahead.
Credit card
After a stellar performance by the credit card sector this
year, we expect charge-offs on our bankcard ABS master
trust performance index to stay in the 3.0-3.5% range in
2013, near all-time record lows. 30+ delinquencies andcharge-offs on our index stood at 2.42% and 3.36%,
respectively, for October 2012, having fallen from 4.38%
and 2.94%, respectively, in January 2012 (Exhibit 5). At
the same time, the 3-month average excess spread at
11.72% and the monthly payment rates at 22.62% for
October are at/near historical highs. Bankruptcy filings
are also expected to remain roughly flat next year versus
Exhibit 5: Bankcard ABS master trust performance
index versus initial jobless claims (monthly): Lossesand delinquencies remain at/near record lows
Source: JP Morgan, Bloomberg, Moodys, ABS 10-Ds
Exhibit 6: Prime auto loan ABS cumulative losses wellwithin expectationsBy vintage (% of original balance)
Source: J.P. Morgan, Intex
Exhibit 7: Subprime auto loan ABS cumulative lossesramping up slower for new vintagesBy vintage (% of original balance)
Source: J.P. Morgan, Intex
250300350400450500550600650
1%
3%
5%
7%
9%
11%
13%
Jan-00 Jan-03 Jan-06 Jan-09 Jan-12
Charge-offs3-month Average Excess Spread30+ Delinquencies
Initial Jobless Claims (right)
0.0%
0.2%
0.4%
0.6%
0.8%
1.0%
1 7 13 19 25
Deal age (months)
2009 2010 2011 2012
0%
2%
4%6%
8%
10%
12%
14%
1 7 13 19 25
Deal age (months)
2009 2010 2011 2012 2007
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8/9/2019 Abs Outlook 2013
6/15
US Fixed Income StrategyUS Fixed Income Markets 2013 Outlook
November 21, 2012
Amy Sze, CFAAC
(1-212) 270-0030
Kaustub Samant (1-212) 834-5444
J.P. Morgan Securities LLC
6
this year, another positive factor for credit card
performance.Auto
In the auto sector, we expect losses on outstanding
vintages to continue on a pace that is well within
expectations (Exhibit 6 and Exhibit 7). On an aggregate
basis, the 2010 and 2011 prime auto vintages have seen
excellent performance with cumulative losses tracking
0.7% area. The 2012 vintage looks to be slightly worse,
close to 1%, albeit the transactions are still relatively
unseasoned. On the subprime side, cumulative losses on
recent vintages will likely be around the 10% range. Of
course, the dispersion among subprime auto ABS pool
performance is much wider, with the pools of deepsubprime obligors consistently experiencing 20+%
cumulative losses and the higher credit pools under 10%.
Furthermore, losses and delinquencies are running quite
low relative to the building credit enhancement on auto
ABS transactions.
While we have seen marginal slippage in auto loan pool
quality in the 2012 pool, we do not anticipate a
significant negative impact on performance. We expect
the steady upgrade of subordinate ABS tranches to
continue. Finally, auto ABS prepayment speeds should
continue to incrementally increase for the newest vintage,
as auto sales continue a recovery back to 15mn saar(Exhibit 8). Aggregate prime and subprime auto loan
ABS speeds are currently running in the 1.2% and 1.4%
ABS areas, respectively. Historically, with 16mn saar,
the 2005 vintage prime and subprime pools stabilized at
about 1.4% and 1.6% ABS, respectively.
Student loan
On FFELP student loan ABS, we expect prepayment
speeds to normalize at the 2-4% levels from the
temporary highs reached this year due to the presidents
special consolidation program. According to Sallie
Maes ABS reports, prepayment rates on its non-
consolidation trusts increased substantially to 7-10% in2Q12 from 2-4% in 4Q11 (Exhibit 9). Aside from such
special opportunities from the government, refinancing
options and incentives in the student loan space will be
extremely limited in the year ahead. In addition, the job
market is unlikely to be strong enough to support
significant improvement in ability or willingness of
borrowers to pay back student loan debt.
Exhibit 8: Auto ABS prepayment speeds increase withhigher auto sales
Source: JP Morgan, Bloomberg, Intex
Exhibit 9: FFELP speeds should normalize as the impact ofthe presidents special consolidation program in 1H12 fadesSLMA non-consolidation pools
Source: Sallie Mae
Exhibit 10: Private credit student loan ABS performancestabilizing with unemployment ratesSLMA total delinquencies and defaults (as % of loans in repayment) versusunemployment rate (%)
Source: Sallie Mae, Bloomberg
6
10
14
18
22
0.6
0.8
1.0
1.2
1.4
1.6
1.8
2.0
2.2
Oct-02 Oct-04 Oct-06 Oct-08 Oct-10 Oct-12
Subprime Auto ABS Speeds (% ABS, left)
Prime Auto ABS speeds (% ABS, left)
Auto Sales (unit mn saar, right)
0%
2%
4%
6%
8%
10%
12%
Mar-08 Mar-09 Mar-10 Mar-11 Mar-122002 2004 20052006 2007 20082010
4%
5%
6%
7%
8%
9%
10%
1%
3%
5%
7%
9%
Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12
Annualized Defaults (left) 90+ Delinquencies (left)
Unemployment rate (right)
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8/9/2019 Abs Outlook 2013
7/15
US Fixed Income StrategyUS Fixed Income Markets 2013 Outlook
November 21, 2012
Amy Sze, CFAAC
(1-212) 270-0030
Kaustub Samant (1-212) 834-5444
J.P. Morgan Securities LLC
7
For the private credit student loan ABS, we expect
performance to remain stable into next year. Given thechallenges facing job seekers, there is limited room for
improvement. For the SLM A pools, delinquency and
default rates stand at 3.81% and 3.73%, respectively,
compared to 3.76% and 4.30% one year ago (Exhibit 10).
Credit conditions will drive prepayment rates, which
should stay low due to the lack of alternative financing
options.
Cross border
We expect USD ABS backed by foreign collateral
domiciled in the UK, Australia, and Canada to maintain
the strong performance we saw in 2013. The cross-
border programs continue to offer diversification andhigh credit quality, with incremental spread pickup for
US ABS investors. In Canada, JP Morgan economists
expect full-year 2013 GDP growth of 2% versus 2.1% for
2012. This would leave the unemployment rate in
Canada relatively flat until 2H13 at 7.1% versus 7.4%
currently. For the UK, unemployment is forecasted to
end at 8.6% in 2013 versus 7.93% in September 2012.
However, GDP growth in 2013 is expected to be stronger
at 1.8% versus flat in 2012. Home prices are expected to
be essentially flat in the UK next year. The economy is
expected to stay stronger in Australia than in the US, the
UK, and Canada despite a projected slowdown to 2.5%
growth in 2013 versus 3.5% this year. Unemployment isexpected to remain low: 5.4% in 4Q13 versus 5.5% at the
end of 2012.
Rating migration: The surveillance
game
Overall in the ABS market, we expect negative rating
volatility to continue to decline in 2013 as it did in 2012,
aside from specific headline credit events. With more
ABS sponsor ratings turning to a stable outlook,
seller/servicer-related risks to ABS ratings and
performance should continue to decline in 2013. In
2012, Moodys upgraded 85 bonds and downgraded 75,while S&P downgraded 519 bonds and upgraded 131
bonds. The S&P downgrades were heavily concentrated
in the FFELP space, close to 70% of all instances of ABS
rating downgrades (or over 350 downgrades). This was
mainly due to S&Ps downgrade of the US sovereign
rating to AA+ from AAA in August 2011, as well as
downgrades in the banking industry (swap
counterparties). In addition, downgrades were mainly in
seasoned tranches issued before 2008. Upgrades across
the rating agencies were once again concentrated in theauto ABS sector. We summarize actions taken by
Moodys and S&P over the past two years and further
break these down by asset class and vintage (Exhibit 11).
We expect subordinate auto ABS to continue to see
upgrades from the rating agencies in 2013, as each new
vintage performance has improved and credit
enhancement remains more than sufficient. Moodys
upgraded 43 bonds from 2011 vintage auto loans and 8
from the 2010 vintage. Similarly, S&P upgraded 18
tranches from 2011 and 16 from 2010. In many cases,
rating agencies reduced their expected cumulative losses
as they upgraded bonds. We would expect this trend to
continue next year as well. Origination standards in auto
loan ABS have stayed strong.
Over the last two years, private credit student loans have
borne the brunt of rating agency downgrades, but the
pace has slowed and should slow further as performance
stabilizes in 2013. In 2011, Moodys downgraded 81
private credit student loan tranches. In 2012, S&P joined
in the action and downgraded 57 tranches. National
Collegiate senior bonds have now been downgraded to
CC. Senior 2003 and 2004 Sallie Mae bonds have been
downgraded to the AA or BBB range. We note,
however, that these downgrades have been mostly
focused on seasoned pre-2008 transactions. Over the lasttwo years, neither S&P nor Moodys have downgraded
any private credit bonds issued after 2008, which reflects
the better collateral and stronger structures present in
new-issue bonds.
On the FFELP side, more rating headlines are possible
with the threat of the fiscal cliff looming over the US
sovereign rating. If Moodys or Fitch were to downgrade
their AAA US sovereign ratings, the corresponding AAA
FFELP ABS ratings would be in jeopardy. On the
positive side, we expect the ABS markets reaction to
negative FFELP rating volatility to be more muted than
when S&P first took action. While S&Ps downgradestemporarily widened AAA FFELP ABS spreads by
approximately 5bp, these spreads have since recovered
and tightened further (3-year AAA FFELP ABS are
currently at 20bp).
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8/9/2019 Abs Outlook 2013
8/15
US Fixed Income StrategyUS Fixed Income Markets 2013 Outlook
November 21, 2012
Amy Sze, CFAAC
(1-212) 270-0030
Kaustub Samant (1-212) 834-5444
J.P. Morgan Securities LLC
8
Exhibit 11: Moodys and S&P rating actions: Less negative rating volatility likely in 2013, but FFELP linked toUS sovereign ratingNumber of instances. Rating actions through November 16, 2012.
Source: JP Morgan, Moodys, S&P, Bloomberg
Vintage
Asset Class Down Up Down Up Down Up Down Up
Pre 2007 Total 203 84 67 52 54 16 426 65
Auto Loan 20 3 4
Credit Card 2 2 18
Equipment 1 1
FFELP 53 1 12 2 282 1
Other 79 57 67 52 34 10 92 37
Private Credit 70 4 5 49 92007 Total 23 62 5 3 13 33 91 13
Auto Loan 42 1 5 27 1
Credit Card 2 2 2 7
Equipment 4 2
FFELP 5 1 4 74
Other 7 13 4 2 2 6 7 2
Private Credit 11 1 8 1
2008 Total 1 28 3 2 51 18 1 9
Auto Loan 26 2 2 16 8
Credit Card 1 1
FFELP 1 2 43 1 1
Other 2 1
Private Credit 6
2009 Total 17 6 12 16 1 12
Auto Loan 10 14 6
Equipment 3 2
FFELP 12
Other 2 6 2 1 4
2010 Total 30 20 28 18 29
Auto Loan 30 8 16 16
Credit Card 4 1
Equipment 6 2 4
FFELP 1 24
Other 5 8
2011 Total 53 20 26
Auto Loan 43 18
Equipment 1
FFELP 2 20
Other 7 8
2012 Total 2 3
Other 2 3
Grand Total 227 221 75 138 178 101 519 157
Moody's S&P
Year of Rating Action Year of Rating Action
2011 2012 2011 2012
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November 21, 2012
Amy Sze, CFAAC
(1-212) 270-0030
Kaustub Samant (1-212) 834-5444
J.P. Morgan Securities LLC
9
Regulatory: The waiting game
Although Dodd-Frank passed in 2010, ABS market
participants are still waiting for final rules on most of the
key regulations, a waiting game that will likely continue
into 2013. As currently outlined, we do not believe that
any single component of Dodd-Frank poses an
insurmountable challenge for ABS issuers or investors.
However, once implemented, Dodd-Frank as a whole
will result in higher regulatory compliance costs,
stringent reporting requirements, and more bank capital
requirements. Reg AB II, risk retention, and the Volcker
rule are three of the most important components of
Dodd-Frank impacting ABS that are yet to be finalized.
The risk retention rule, which calls for issuers to retain5% of the credit risk of the assets, should not keep issuers
from coming to the ABS market. ABS issuers, for the
most part, already have sufficient skin in the game
through retained first-loss pieces, subordinate tranches,
representative receivable pools, and/or seller interest. It
is also likely that FFELP ABS may get a carve-out due to
the government guarantee on the underlying collateral.
Some sections of the risk retention ruling that are
problematic for MBS issuers, such as premium capture
cash reserve account (PCCRA), may be re-proposed next
year before a final rule is issued.
Reg AB II will result in the most substantive changes forABS issuers. As last, proposed by the SEC in August
2011, Reg AB II calls for CEO certification of the
prospectus, distribution of a cash flow model, detailed
disclosure of loan-level data, and more stringent
disclosures by 144A issuers. Currently, ABS issuers do
not provide loan-level data that satisfy Reg AB II
requirements. (Historically, only MBS issuers made loan
tapes available.) Implementing systems to satisfy
reporting requirements will result in higher costs. These
costs will disproportionately increase for smaller, non-
benchmark issuers utilizing the 144A market, who, under
the proposed Reg AB II, would have to meet similar
standards as SEC-registered transactions. We understandthat the cash flow model requirement has been
temporarily shelved by the SEC after its review of
industry comments. The ABS market will simply have to
wait for the final Reg AB II ruling to see exactly what
will be required. The specifics on the loan-level
reporting will be very important for issuers in every ABS
asset class. The timing of that important release is
uncertain, with the best guess being early next year. It is
also uncertain how much time ABS issuers will have to
implement the required changes, with at least one yearpreferred by the ABS market. The grace period for
implementation would be critical to ensure a smooth
transition period and to prevent any interruption in
issuers access to funding.
The Volcker rule, which limits proprietary trading andprevents banks from owning or sponsoring hedge funds,may have unintended consequences for the ABS market.As written, the rule exempts securitization vehicles fromits framework if they only contain loans, which may betoo narrow for certain ABS asset classes. It placesrestrictions on relationships between banks and hedgefunds/private equity funds, which, as defined, could also
include some ABS vehicles. Since ABS seems to beaccidentally captured in the regulation, we would expectthe final regulation to include a broad enough carve-outsuch that securitization can continue unimpaired.
Lastly, the final risk-based capital rules will be
implemented for bank trading desks on January 1, 2013,
and those for bank balance sheets will go into effect in
2Q13. The final Simplified SFA (SSFA) calculation that
was released this year may result in higher capital for
various ABS sectors, if adopted. With credit
enhancement levels outweighing asset performance (i.e.,
losses), the SSFA capital requirement formula imposes
harsher capital requirements on high-quality ABS (withlow subordination). The impact of applying SSFA could
be the harshest for ABS with low levels of credit support,
which would generally be high-quality collateral (e.g.,
prime auto loans). We expect most large banks to be
able to adopt a reasonable approach for ABS holdings,
and the capital requirement should not be an obstacle for
ABS purchases.
Trading themes: Find a pickup game
We expect technicals to continue to drive ABS spreads in
2013, given that credit fundamentals are not expected to
change materially as the economy remains on the path of
a very slow recovery. While fiscal drags willsignificantly reduce GDP growth in 1H13, the impact on
the ABS market should be limited to investor sentiment,
rather than ABS credit performance. We expect ABS
spreads to remain relatively stable amid potential bouts
of supply-induced or headline-induced market volatility.
Adjusted for spread volatility, we have seen good value
in ABS versus other credits in recent years. In order to
account for volatility, we calculate a proxy Sharpe
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US Fixed Income StrategyUS Fixed Income Markets 2013 Outlook
November 21, 2012
Amy Sze, CFAAC
(1-212) 270-0030
Kaustub Samant (1-212) 834-5444
J.P. Morgan Securities LLC
10
ratio taking the most recent nominal spreads across asset
classes and dividing them by trailing spread volatility(Exhibit 12). Spread volatility is calculated as one
standard deviation of quarterly changes in spread over a
two-year period. We use a long time horizon for our
volatility calculations since our ABS spread updates are
weekly and tend to be stickier than other asset classes.
Judging by its Sharpe ratio, 3-year AAA card ABS is the
most attractive asset class. Although they currently offer
only 18bp of spreadsfar lower than corporates, CMBS,
or agency MBStheir spread volatility is only 3bp.
Subordinates and AAAs in other ABS sectors, such as
autos and private credit student loans, also have low
volatility (and high Sharpe ratios) compared to other
asset classes. The FFELP ABS sector has seen relativelymore volatility mainly due to negative rating actions
connected to US sovereign and bank counterparty
downgrades. More broadly, our analysis suggests that
ABS has served as a safe asset class with low volatility.
We expect this trend to remain intact in 2013.
ABS will continue to provide a safe haven to investors
concerned about the fiscal cliff and in need of higher-
yielding Treasury surrogates. The technicals, supported
by QE3, point to overall tightening trends next year with
investors hungry for credit and yield.
AAA credit card and auto loan ABS serve as
effective Treasury surrogates but go with non-benchmark names for spread pickupWithin the credit card sector, retail names such as
COMNI and WFNMT still offer 30bp and 50bp
pickup, respectively, on the top bankcard ABS names.
In addition, cross-border issuers from the UK could
offer as much as 40bp pickup on top US bank
sponsors, while Canadian issuers offer about 20bp
incremental spread. In the auto sector, the USD
Australian auto ABS from Macquarie Bank continue
to offer a substantial spread pickup due to a
predominantly smaller group of investors that can
purchase ABS backed by non-US domiciled
receivables.
We like short front-pay AAA private credit
student loan ABSSLMA 2012-E A-1 (1.7 year AAA) came at LIBOR
+75bp in mid-October. The sector continues to see
the cheapest levels for such short duration AAA
bonds. The front-pay bonds are particularly robust
with substantial credit support and an immediately
Exhibit 12: ABS sectors historically offer better volatility-adjusted spreads than comparable creditsSpread (bp). Vol = 1 standard deviation of quarterly changes in ABS spreads
Source: JP Morgan
Exhibit 13 Subordinate subprime auto ABS cheap tocomparably rated corporates
bp
Source: JP Morgan
Exhibit 14: Levered opportunities limited with tightening
spreads
Source: JP Morgan
Spread Vol Spread/Vol
AAA Credit Card ABS 3-year 18 3 6.7
Agency MBS Nominal Spread 124 24 5.2
Private SLABS 7-year AAA 215 44 4.8
BBB Credit Card 3-year 70 19 3.7
BBB Subprime Auto ABS 3 -year 180 56 3.2
Private SLABS 3-year AAA 125 40 3.1
Prime Auto ABS 3-year AAA 18 6 2.9
BBB Financials 3-5-year 216 80 2.7
Subprime Auto ABS 2-year AAA 26 10 2.5
AAA Financials 3-5-year60 25 2.4
AAA Non-Financial Corportes 3-5 -year 28 13 2.2
AAA Corpprates 3-5-year 38 18 2.2
AAA FFELP ABS 3-year 20 9 2.1
CMBS 2005 A4 61 31 2.0
Agency debt 3-year 10 10 1.0
0
100
200
300
400
500
Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12
Bankcard ABS Subprime Auto Loan ABS
JULI Financials JULI Automotive
Sector Rating
WAL
(yrs)
ABS
Spread
(bp) Yield
Levered
Yield
ABS
Spread
(bp) Yield
Leve
Y
Subprime Auto BBB 3 315 3.72% 10% 180 2.25%
Prime Auto BBB 3 150 2.07% 5% 210 2.10%
UK RMBS AAA 3 160 2.13% 4% 80 0.81% -
Private Credit SL AAA 3 235 2.61% 6% 146 1.46%
New Issue CMBS AAA 3 65 1.22% 2% 40 0.85%
New Issue CMBS BBB 10 790 9.83% 29% 435 5.98% 1
As of February 2012 As of November 2012
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US Fixed Income StrategyUS Fixed Income Markets 2013 Outlook
November 21, 2012
Amy Sze, CFAAC
(1-212) 270-0030
Kaustub Samant (1-212) 834-5444
J.P. Morgan Securities LLC
11
open principal window. The long-last cash flow
AAA A-2B (AAA 4.48 years) on SLMA 2012-Ecame at LIBOR +175bp. Given that the private credit
sector tends to be more vulnerable to volatility, we
prefer the shorter, more liquid tranche with much
shorter credit exposure as well.
Subordinate auto ABS cheap to comparably rated
corporatesThe most recent subordinate BBB prime and
subprime auto loan ABS spreads priced at 140bp and
180bp to swaps, respectively. The BBB prime auto
loan ABS are essentially flat to comparably rated
JULI automotive corporates of 3- to 5-year maturities,
while the subprime auto loan ABS offer roughly 40bpof spread pickup (Exhibit 13). In comparison to the
unsecured corporates, the subordinate auto ABS paper
has roughly 3-year WAL and a relatively short and
consistently positive rating outlook. Spread
tightening potential can be realized by rolling down
the yield curve and/or getting rating upgrades.
Furthermore, the subordinate auto ABS sector has
shown lower spread volatility over the past two years.
With the BBB subordinate ABS, there remains
opportunity to finance purchases and achieve decent
levered yields (Exhibit 14) around 4-5%, as financing
costs have come down with asset spreads this year
(haircuts unchanged). Given these positive ABSfeatures, we believe spreads will go even tighter
(should be through comparable corporates) and can
continue to outperform.
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US Fixed Income StrategyUS Fixed Income Markets 2013 Outlook
November 21, 2012
Amy Sze, CFAAC
(1-212) 270-0030
Kaustub Samant (1-212) 834-5444
J.P. Morgan Securities LLC
12
Exhibit 15: 2012 ABS spread performanceSpread to benchmark (bp)
Note: Tier 1 names represented by above
Source: JP Morgan
Exhibit 16: Cross-sector spreads (3-year)bp
Source: JP Morgan
Exhibit 17: Cross-sector yields (%)5-year AAA Card ABS and Treasury, JULI Financials, FNMA Current Coupon 30-year
Source: JP Morgan
Current YTD Current YTD
Benchmark 11/16/12 Change Avg Min Max Benchmark 11/16/12 Change Avg Min Max
Credit Card - Fixed Rate Student Loans (FFELP)
2-yr Swaps 6 -4 7 4 10 3-yr Libor 20 -35 31 20 55
3-yr Swaps 10 -4 11 7 14 7-yr Libor 65 -30 74 65 100
5-yr Swaps 23 -2 24 23 25 Private Credit Student Loan
10-yr Swaps 40 -5 44 40 45 AAA 3-yr Libor 125 -110 167 125 235
B-Piece (5-yr) Swaps 70 -20 74 65 90 Global RMBS (UK Bullet)
C-Piece (5-yr) Swaps 90 -45 111 90 135 3-yr AAA Libor 50 -110 118 50 160
Credit Card - Floating Rate 5-yr AAA Libor 80 -90 135 80 170
2-yr Libor 13 1 8 6 13
3-yr Libor 18 2 13 12 18 Stranded Assets
5-yr Libor 30 5 23 22 30 2-yr Swaps 6 -6 7 6 12
10-yr Libor 44 6 38 38 44 3-yr Swaps 12 -5 12 10 17
B-Piece (5-yr) Libor 70 -20 75 65 90 5-yr Swaps 25 -5 27 25 30
C-Piece (5-yr) Libor 135 -35 111 100 135 10-yr Swaps 60 20 60 40 60
Aut o - Pri me Auto - Su bpr ime
1-yr EDSF 7 -1 5 1 8 1-yr EDSF 20 -25 29 12 45
2-yr Swaps 12 -6 11 2 18 2-yr Swaps 26 -44 48 26 70
3-yr Swaps 18 -12 21 10 30 3-yr AA Swaps 70 -90 99 70 160
B-Piece Swaps 85 -20 90 85 105 3-yr A Swaps 120 -130 165 120 250
YTD YTD
0
100
200
300
Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12
Credit Card ABSPrime Auto Loan ABSFFELP Student Loan ABSJULI AA Bank (1-3 year)CMBS
Current1818205990
0
2
4
6
8
10
Jan-10 Oct-10 Jul-11 Apr-12
TreasuryAAA Card ABSAgency MBSFinancials
Current0.7
1.02.23.0
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US Fixed Income StrategyUS Fixed Income Markets 2013 Outlook
November 21, 2012
Amy Sze, CFAAC
(1-212) 270-0030
Kaustub Samant (1-212) 834-5444
J.P. Morgan Securities LLC
13
Exhibit 18: 3-year fixed-rate AAA ABS spread to swaps
bp
Exhibit 19: 5-year fixed-rate AAA ABS spread to swaps
bp
Exhibit 20: 3-year sing le-A fixed-rate ABS spread to swapsbp
Source: JP Morgan
Exhibit 21: 3-year floating-rate AAA ABS spread to Libor
bp
Exhibit 22: 5-year fixed-rate AAA-ABS spread to
Treasuriesbp
Exhibit 23: 3-year floating-rate AAA ABS spreads to Libo rbp
Source: JP Morgan
01020304050607080
05
101520253035404550
Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12
Prime AutoCredit CardSubprime Auto (Right)
Current12
626
15
20
25
30
35
40
45
50
55
Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12
Credit Card
Stranded Asset
Current
23
25
0
50
100
150
200
40
60
80
100
120
140
160
180
Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12
Credit cardPrime AutoSubprime Auto (Right)
Current50
8570
0
20
40
60
80
Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12
Credit Card
Prime Auto
Student Loan
Current18
18
20
20
40
60
80
Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12
Credit Card
Stranded Asset
Current
38
40
0
50
100
150
200
250
300
350
400
450
Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12
US$ UKRMBSPrivate CreditStudent Loans
Current
50
125
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