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February 19, 2016  

Skopos Deal Highlights Subprime-Auto Woes

The collateral for Skopos Financial’s most recent securitization of subprime auto loans is performing worse than expected, feeding fears of an impending liquidity crunch in the asset class.

At issue is a $154 million transaction that Skopos completed on Nov. 9 with Citigroup running the books. That issue’s top class earned ratings of A/AA from DBRS and Kroll, but already has experienced enough collateral defaults to approach a “cumulative net loss ratio trigger event” set by Kroll.

Should losses reach that level, Skopos would have to stop collecting excess cashflows and redirect the money to bondholders.

Such an event would make it difficult for the Irving, Texas, company, founded by former Drive Financial executive Mark Gallas, to continue doing business as usual — and would make it virtually impossible for Skopos to raise additional capital through securitization. Sources said other deep-subprime lenders including Go Financial and United Auto Credit face similar pressures due to rising losses among the loans underpinning their securitizations.

“For these smaller firms, securitization is their only source of funding in this space,” one source said. “It only takes one deal of theirs to go sideways in terms of performance and they can impact the whole subprime-ABS market.”

The point of building a net-loss-ratio trigger into a deal is to protect bondholders, so investors holding Skopos’ paper aren’t likely to be affected by weakening collateral. But increasing delinquencies and losses among deep subprime borrowers across the board are adding to concerns that the industry is vulnerable to a “perfect storm” of market forces including deteriorating credit quality, declining vehicle-resale values and rising interest rates. Deep-subprime borrowers typically have credit scores below 550, and the loans often have terms of up to 84 months and coupons above 20%.

“Subprime-auto-loan ABS delinquencies continue to rise, indicating future defaults and net losses may be in the pipeline,” Wells Fargo managing director John McElravey wrote in a Feb. 12 report.

That investors are increasingly nervous is indicated by recent trading in the secondary market. From Feb. 4-11, spreads on the subordinate tranches of subprime auto-loan deals widened by 40-65 bp, according to J.P. Morgan. Double-A-rated bonds, for example, were changing hands at an average of 155 bp over swaps on Feb. 11, up from 110 bp a week earlier. Bonds rated triple-B blew out 65 bp to 295 bp during the same period.

To complete its last deal, Skopos had to offer investors unusually generous terms, with the top class of one-year bonds pricing at 300 bp over eurodollar futures. One reason for that: Nearly half of the collateral loans were originated in Texas, where the collapse of oil prices has taken a toll on the economy.

Skopos, founded in 2011, is led by a team that includes Gallas, chief executive Daniel Porter and former Drive Financial executives Jody Day and David Sivils. Drive, a routine issuer of subprime-auto-loan securitizations prior to the financial crisis, was acquired by Santander in 2006.

Lee Equity, a New York firm led by private equity pioneer Thomas H. Lee, owns a 97% stake in Skopos.