Institutions that lend funding for the purchase of automobiles may issue auto loan backed ABS.
Auto loans are typically amortizing with a term of three to five years.
Prepayment risk exists because borrowers may sell or trade-in their vehicles to buy new ones, the car can be repossessed, borrowers may destroy their cars in accidents and have the loans paid off with insurance money, or borrowers may refinance if rates drop far enough.
Prepayment can be measured by absolute prepayment speed, which is a percentage of the collateral. The absolute prepayment speed can then be used to create a single monthly mortality (SMM) rate.
Auto loans represent the second largest sub-sector of the ABS market.
Auto loan ABS are generally issued as an owner trust structure, which allows for a time tranching of the senior class, and credit tranching to issue subordinated debt. The sequential senior bonds allow issuers to tailor issuance to meet the different maturity preferences of fixed-income investors.
Auto loan ABS can also be structured as a grantor trust in which certificates represent a proportionate beneficial interest in the trust. Principal is passed through to investors on a pro rata basis. The certificates can be tranched into senior and subordinated classes, but it does not allow time tranching.