Abs Outlook 2013

8/9/2019 Abs Outlook 2013

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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

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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Amy Sze, CFAAC

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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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Amy Sze, CFAAC

(1-212) 270-0030



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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Amy Sze, CFAAC

(1-212) 270-0030



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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Amy Sze, CFAAC

(1-212) 270-0030



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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Amy Sze, CFAAC

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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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Amy Sze, CFAAC

(1-212) 270-0030



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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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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Amy Sze, CFAAC

(1-212) 270-0030



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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(1-212) 270-0030



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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Amy Sze, CFAAC

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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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(1-212) 270-0030



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


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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(1-212) 270-0030



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


Prime AutoCredit CardSubprime Auto (Right)

Current12

626

15

20

25

30

35

40

45

50

55


Credit Card

Stranded Asset

Current

23

25

0

50

100

150

200

40

60

80

100

120

140

160

180


Credit cardPrime AutoSubprime Auto (Right)

Current50

8570

0

20

40

60

80


Credit Card

Prime Auto

Student Loan

Current18

18

20

20

40

60

80


Credit Card

Stranded Asset

Current

38

40

0

50

100

150

200

250

300

350

400

450


US$ UKRMBSPrivate CreditStudent Loans

Current

50

125


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