Citi - Auto ABS Primer

See Disclosure Appendix A1 for the Analyst Certification and Other Disclosures.

U N I T E D S T A T E S SEPTEMBER 15, 2005

F I X E D I N C O M E

R E S E A R C H

Asset-Backeds and Mortgage Credit UNITED STATES

Mary E. Kane (212) 816-8409 [email protected] New York

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Guide to Auto ABSs

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SEPTEMBER 15, 2005

Guide to Auto ABSs

September 15, 2005 Guide to Auto ABSs

Citigroup Global Markets 4

Contents

Executive Summary ......................................................................................................................... 3

Roadmap to Retail Auto Loan ABSs 7 Introduction...................................................................................................................................... 7 Auto Loans — Collateralized Consumer Assets ................................................................................ 8 Market Segmentation and Loan Characteristics................................................................................. 8 Loss Curves ..................................................................................................................................... 10

Structures 13 Typical Auto Loan Structures ........................................................................................................... 13 Cash Flow........................................................................................................................................ 14 Alternative Structures....................................................................................................................... 16

Credit Enhancement 18 Rating Agency Credit Enhancement Requirements ........................................................................... 20

Other Risk Factors 21 Servicing Risk.................................................................................................................................. 21 Underwriting and Collections Risks.................................................................................................. 22

Payment Speeds 24 Prime Auto Speeds ........................................................................................................................... 24 Subprime and Nonprime Auto Speeds............................................................................................... 25

To Call or Not To Call — Auto ABSs’ Early Call Option 26

Other Auto ABS Products 29 Dealer Floor-Plan Loans................................................................................................................... 29 Fleet Financing for Auto Rental Companies...................................................................................... 33 Auto Leases ..................................................................................................................................... 36 General Motors Novel Structure Eliminates PBGC Risk ................................................................... 40 Vicarious Tort — No Longer a Risk ................................................................................................. 41

Appendix 42 List of Prime, Nonprime, and Subprime Lenders............................................................................... 42

The author would like to thank Elizabeth Escobar for formatting this report. Her attention to the small details is most appreciated. In addition, thanks to Cecilia Sarmas and Norma Lana in the editorial department, for their constructive suggestions and valuable assistance.



Test-drive the auto ABS market for high-quality, well-diversified,

and liquid assets with a strong track record.

Important Sector of the ABS Market

Auto ABSs are one of the largest sectors of the ABS market, representing approximately 21% of all ABS issuance. Record-setting issuance through late-August 2005 reached $76 billion, some 30% ahead of the comparable period in 2004.

The auto ABS market reached the pinnacle of its importance during 2005. In the first half of 2005, access to the unsecured market essentially dried up for two US auto manufacturers when they lost investment-grade status. Those events could have presented significant liquidity problems.

Undeterred, the auto ABS market filled in the funding gap for the manufacturers (at somewhat wider spreads). Two captive finance companies priced approximately double their typical auto ABS supply (roughly $10 billion each) in the first half of 2005.

Principal Market Segments

The retail auto ABS market consists of prime, nonprime, and subprime auto loan receivables. These designations correspond to the expected cumulative losses for a static pool.

Prime sector: Expected cumulative losses of 3% or less. Main lenders are captive finance companies for auto manufacturers (both domestic and foreign) and banks.

Nonprime sector: Expected cumulative losses of 3.01% to 7%. Specialty finance companies and banks dominate the sector.

Subprime sector: Cumulative loss range of 7.01% to 15%. Principal players are specialty finance companies.

The whole loan market (outright sales of auto receivables) has also emerged as an important sector within the auto ABS market. One manufacturer’s agreement to sell $55 billion of receivables to a bank over a five-year period is an example of the additional flexibility that whole loan sales provide. Other segments of the auto ABS market include retail auto leasing, and wholesale dealer floor-plan and fleet financings for auto rental car companies.

Strong Liquidity

The prime retail auto loan segment is the most liquid sector of the auto ABS market. Individual transactions are typically significant ($1 billion plus) and have very good liquidity. Some of the off-the-run prime names (regional banks and infrequent issuers) can offer an attractive spread pickup to prime autos, offering a liquidity premium and comparable credit quality.

Large nonprime and subprime auto names generally have good liquidity as well. There are several large, nonprime and subprime issuers selling transactions on a programmatic basis. These nonprime and subprime issuers offer consistent



performance and sometimes contain a third-party surety guaranty. Although these issues are not as liquid as prime autos, the spread pickup is attractive. (See the Appendix at the end of this report for a list of issuers by sector.)

Well-Diversified Pools of Secured Loans

Auto ABS loans are typically well diversified both geographically and in loan size. The geographical diversification is typically well distributed across the United States. Loan sizes display homogeneity; the lumpy sizes that sometimes exist in mortgage, equipment, or other types of ABS pools are generally not an issue in the auto sector. Auto lenders typically file a lien on the financed vehicle, perfected with a UCC filing, and assign the lien to the trust. The perfected security interest provides added protection for the lender. Although autos are depreciating assets, the security interest provides more protection for the lender than unsecured obligations, such as credit cards.

Stable Prepayment Characteristics

In general, auto speeds are stable. This is because there is no incentive for auto owners to refinance their vehicle if interest rates decline. Autos are unlike the mortgage market in that respect. Since autos are depreciating assets, the cost of refinancing a used auto is greater than the cost of financing a new vehicle. Payment speeds are generally expressed as an “ABS,” or asset-backed speed. Transactions generally pay from an ABS of 1.4 to 1.7.

Auto Call Option

Most trusts (two-thirds of those we examined) call the transactions within one to four months of the eligible call exercise date. Very few trusts did not exercise the call, or only exercised the call after a long delay. Auto ABSs typically have a call option when the collateral pool has a 10% balance and frequently price to the expected call. If not called, autos can extend by as much as 12 to 15 months to maturity. The call option decision is not clear-cut, however, as it exists in the corporate bond world, where the decision is purely interest rate driven. The decision also takes the cost of administering the outstanding pool into account.



Roadmap to Retail Auto Loan ABSs

Introduction Auto loan ABSs are a major and liquid sector of the ABS market. In a typical year, auto ABS issuance accounts for approximately one-third of supply in the ABS market. In the past three years, however, a refinancing explosion in the HEL sector knocked the symmetry of typical ABS market supply off balance. The HEL sector has dominated market supply during this time. Although autos shrank as a percentage of total new issuance, it remains an important and growing sector of the market, registering $76 billion of supply through late-August 2005. Auto ABS supply is 30% ahead of the comparable period in 2004.

Vehicles are the most widely held nonfinancial assets in America — 86% of families either own or lease a vehicle.1 Vehicles represent a key component of the economic and social fabric of America. A vehicle is not just basic transportation — it represents a means to work, other opportunities, and a lifestyle. The average US consumer unit owns 2.0 vehicles, according to the US Department of Labor. Moreover, vehicle ownership increased in the United States by approximately 5% from 2001 to 2002.2

We show the importance of auto loans to the new issue market in Figure 1. We see that in 2005 auto loans compose 11% of new issue volume. Outstanding auto securities amount to approximately $193 billion as of July 31, 2005, and account for 21% of all prior issuance in the ABS market. The term “auto” loans includes light trucks and SUVs. The auto new issuance numbers also include dealer floor-plan loan and lease securitizations.

Figure 1. ABS Total New Issue Volume Through 26 Aug 05 — $676 Billion

Home EquityLoans 39%

Credit Cards 4%

Auto Loans 11%

Equipment 1%Student Loans 5%

Man. Housing 0%

Other 40%

Sources: SDC Database and Citigroup.

1 “1998 Survey of Consumer Finances,” A.B. Kennickell, M. Starr-McCluer, and B.J. Suretts, Federal Reserve Bulletin,

January 2000. 2 Bureau of Labor Statistics’ Survey of Consumer Expenditures, report in the first quarter of 2004 (for the year 2002).

The average US family owns two vehicles.



Benefits of Auto Loans

Auto loans were one of the earliest products introduced to the securitization market. Investors favored auto loans as a result of their many benefits:

➤ Large and diversified pools of consumer obligations;

➤ Security interest in underlying vehicles and receivables;

➤ Bankruptcy-remote assets from the underlying seller-servicer;

➤ Short-term exposure — an average life of generally less than two years;

➤ Low losses in the prime sector and very stable track record; and

➤ Consistent prepayment speeds with little volatility.

Auto Loans — Collateralized Consumer Assets A perfected security interest in tangible collateral is a positive aspect to this asset class. Auto loan ABSs possess a security interest in the vehicle and proceeds perfected with a uniform commercial code (UCC) filing. The UCC filing delineates the lender’s security interest in the vehicle. The lender typically files the UCC form with the state where the borrower resides. The UCC lists the lender as lien holder. The lender lien is also recorded on the vehicle title issued by the respective state department of motor vehicles. The borrower is unable to sell the vehicle without clearing the lien to the lender.

This secured feature of auto ABSs is in contrast to unsecured obligations such as credit cards. The purpose of an auto loan obligation is also a positive attribute. A vehicle ranks highly in the consumer’s “hierarchy of needs.” Many people will make paying their monthly vehicle loan payment a priority, even in hard times, as they need vehicles to get to work and require basic transportation. Consumers may get behind on other obligations, but a vehicle represents a means to a livelihood and other opportunities.

Autos preceded credit cards as a securitized asset class in the ABS market. But it took several years for investors to develop a more sophisticated understanding of structured product. The market readily accepted auto loans as an asset class, but it took longer to accept pools collateralized by unsecured credit obligations. A few years later the market evolved with successful offerings of unsecured credits, such as credit card receivables.

Market Segmentation and Loan Characteristics The auto loan market is segmented according to different types of lenders, so named because of the asset underwriting risk characteristics:

➤ Prime — top quality obligors, least likely to default. Expected cumulative losses for a static pool are 3.0% or less;

➤ Nonprime — higher risk than prime obligors; may have some slow-paying credit history. Cumulative losses typically run from 3.01% to 7% for a static pool; and

The benefits are numerous.

Auto ABSs possess a security interest in the vehicle and proceeds.

Autos preceded cards in the ABS market evolution.



➤ Subprime — highest default probabilities. Obligors may have low income, a prior bankruptcy, or poor credit history. Cumulative losses may amount to in excess of 7%.

Net cumulative losses measure total net losses for a given static pool. Higher risk paper will incur greater cumulative losses. Therefore, cumulative loss experience helps to identify which sector a particular issuer belongs in.

It is also useful to compare and contrast the sectors of the auto loan market by examining differences in pool underwriting characteristics shown in Figure 2. We list a range of average pool yields, FICO scores, and expected cumulative losses for prime, nonprime and subprime auto issuers.

Figure 2. Average Underwriting Characteristics of Auto Issuers Underwriting Criteria Prime Nonprime SubprimeAverage pool yield 0%–7% 2%–13% 2%–26%Avg. FICO range 680–800 600–680 500–600New vehicle percentage 55–100% 30–50% 0–40%

Expected cumulative losses Less than 3% 3%–7% 7%–15%

Source: Citigroup.

FICO scores are a risk ranking system used by many credit bureaus in compiling consumer credit reports. (Auto lenders will typically pull the credit bureau report for a loan applicant.) A FICO score measures the probability of an individual to default given their credit file. The lower the probability that an individual is likely to default, the higher is their FICO score. Weighted average FICO scores of auto loan pools are a strong indication of the credit quality of the underlying loan contracts. Issuers do not generally report average FICO scores in ABS prospectuses. However, issuers sometimes reference FICO scores in discussions of underwriting credit quality. Many issuers rely on proprietary internal risk models to underwrite loans. However, FICO scores are a convenient way to compare underwriting risks among issuers.

Many auto lenders rely on risk-based pricing models that adjust yield for credit risk. Contract yield, therefore, is an additional strong indicator of the probability of default. Yield ranges delineate differences among high- and lower-quality obligations. Interest rates change over time and with market conditions. However, in general, lower yields are indicative of higher credit quality and lower default probabilities.

Contrasting yields among issuers (prime, nonprime, and subprime) helps to identify the appropriate classification as well. The Federal Reserve Bank tracks rates for auto finance companies and banks and publishes the data monthly in its G-19 and G-20 reports. The relationship of the pool WAC and the market rates for new and used vehicles helps to establish a frame of reference. In addition, nonprime and subprime auto pools tend to contain greater proportions of used vehicles (see Figure 3).

Higher risk assets incur greater cumulative

losses.

Contract yield is another strong indicator.

The Fed tracks auto data.



Figure 3. Federal Reserve Bank G-19 and G-20 Releases, Jan 98–Jun 06

Spread between finance company and bank rates narrowed

2%

4%

6%

8%

10%

12%

14%

Jan 98 Sep 98 Jun 99 Mar 00 Dec 00 Sep 01 Jun 02 Mar 03 Dec 03 Sep 04 Jun 05

Rat

e

Commercial Banks (48-Month New Car Loans) Auto Finance Companies (New Cars)Auto Finance Companies (Used Cars) Prime Rate

Source: Federal Reserve Bank.

Loss Curves The curves in Figure 4 depict differences in the timing of loss recognition. Prime, and nonprime/subprime paper will incur losses at different points in their lifecycle, and their respective loss curves will look quite different. Even though we show prime and subprime/nonprime loss curves on the same chart, total cumulative losses are not equal to each other. Moody’s plots loss curves over 60 months, which correspond to the terms of a typical vehicle installment loan sales contract. Subprime/nonprime lenders recognize losses early in the lifecycle. Losses are more evenly distributed along the curve for prime auto lenders.

Prime Loss Curves

Prime losses are distributed fairly symmetrically along the curve for prime auto loans. As the underwriting risks are fairly low, losses are initially moderate and gradually rise over the life of the pool. Peak losses occur about mid-cycle and level off later in the life of the pool.

Subprime/Nonprime Loss Curves

Nonprime and subprime loss curves tend to occur early in the life of the pool, and then level off. This tendency is what some in the industry call “spike and burn.” This is because of the lower credit quality of the individuals in these pools — credit problems surface early, but then the defaults abate. Subprime and nonprime obligors tend to have lower incomes, little credit history or poor prior credit records, and perhaps a bankruptcy.

The loss curve rises early in the life of the transaction — typically, about 75% to 85% of the losses occur by month 18 and 95% by month 24, with the remaining losses fairly evenly distributed over the remaining life of the transaction. We note, however, that Moody’s and other industry experts affirm that loss curves are becoming more back-ended because of longer loan contracts.

The graph shows loss recognition timing

differences.

Subprime/nonprime losses typically

occur early.



Figure 4. Typical Prime and Subprime/Nonprime Automobile Loss Curves

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41 43 45 47 49 51 53 55 57 59

Months from Origination

Cum

ulat

ive

Loss

Per

cent

of T

otal

Prime AutosSubprime / Nonprime Autos

Source: Citigroup.

Why We Look at Loss Curves

It is possible to forecast early on how an auto pool will perform. The market forms expectations for every issuer about the anticipated amount and timing of losses. These expectations are formed from historical performance and changes in underwriting standards. Investors can evaluate the actual pool performance by comparing it to vintage curves. Any deviation from expectations should be examined.

We show vintage cumulative loss curves for prime, nonprime, and subprime issuers in Figure 5. Citigroup publishes performance data in Citigroup’s Auto Performance Report publication periodically. In order to create the curves, we averaged cumulative loss data for selected lenders by sector and by vintage year. In every sector in Figure 5, the 2003 and 2004 vintages outperformed earlier vintages. The 2005 vintage is also off to a good start. However, since the 2005 vintage has reported only a few months of data, it is too early to predict performance.

It is possible to estimate pool performance

early on.



Figure 5. Vintage Prime, Nonprime, and Subprime Auto Cumulative Loss Curves 2000–2005

Prime Cumulative Losses

0.0

0.5

1.0

1.5

2.0

2.5

0 5 10 15 20 25 30 35 40 45 50

Deal Age (Months)

2000 2001 20022003 2004 2005

Cum

ulat

ive

Loss

es (%

of O

rigin

al B

alan

ce)

Nonprime Cumulative Losses

0

1

2

3

4

5

6

7

0 5 10 15 20 25 30 35 40 45 50Deal Age (Months)

2000 2001 20022003 2004 2005

Cum

ulat

ive

Loss

es (%

of O

rigin

al B

alan

ce)

Subprime Cumulative Losses

0

2

4

6

8

10

12

14

16

0 5 10 15 20 25 30 35 40 45 50

Deal Age (Months)

2000 2001 20022003 2004 2005

Cum

ulat

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Loss

es (%

of O

rigin

al B

alan

ce)

Source: Citigroup.



Structures

Owner trusts are the most common structures in use today. Grantor trusts are an alternate auto structure type and were common in the early days of the ABS market. The primary difference between grantor and owner trusts is the allocation of cash flow among the different classes of securities.

Owner trusts provide the ability to time tranche and to reallocate cash flow among senior and subordinate investors. The owner trust structure has a series of classes in sequential, staggered maturity. There is typically a short-term money-market class, a one-year, a two-year, and a three-year class. The owner trust allows sequential (instead of pro rata) payment of cash flow, and repays investors in order of maturity and seniority.

First, the trust typically pays interest to all classes. Next, the trust directs principal payments to each class in order of maturity (instead of pro rata). The trust allocates all principal payments (typically monthly) to the money market class until it is repaid, then directs all principal payments to the one-year class until it is retired, and so on. Although referred to as money market, one-year, two-year, and three-year classes, there is generally monthly amortization within a narrow window in each of the classes, corresponding to the cash flow of the collateral. In the event of default, cash flow would revert to a pro rata allocation of cash flow.

Grantor trusts accommodate a pass-through structure. The trust pays the cash flow simultaneously to all classes. The grantor trust structure mirrors the actual cash flow of the majority of auto loan contracts. Auto loans typically pay monthly over a period of 36 to 72 months, and sometimes longer.

Typical Auto Loan Structures We show a typical auto loan structure in Figure 6. The seller/servicer originates a pool of auto loans. It sells the receivables, the rights to receive proceeds, and the lien on the vehicles into a bankruptcy-remote grantor or owner trust. The sale is a true sale of assets, meaning that the conditions for sale treatment have been met.

Owner trusts allow time tranching and

reallocating cash flow.

Grantor trusts are pass-through structures.



Figure 6. Typical Auto Loan ABS Structure

Seller Borrowers

ReserveAccount

Servicer

Grantor Trustor

Owner Trust

Investors

Principal and Interest

Monthly Principal and interest


Initial Deposit

Excess Spread

Credit Support

Seller Borrowers

ReserveAccountReserveAccount

Servicer

Grantor Trustor

Owner Trust

InvestorsInvestors

Principal and Interest



Initial Deposit

Excess Spread

Credit Support

Source: Citigroup.

Cash Flow Sequential Payments

Trusts typically pay cash flow sequentially, beginning with the shortest class first, then the second shortest maturity class, and so on. The payment priorities are typically as follows:

1 Servicing fee;

2 Trustee and other fees;

3 Net swap payment (if applicable);

4 Interest in order of seniority and swap termination payment (if applicable);

5 Amount, if any, to be deposited into the reserve account;

6 Principal, in order of seniority;

7 Amount due to the note insurer (if applicable);

8 Remaining amounts in the collection account go to the seller or are “turboed” to the trust. “Turbo” means accelerating the payment of excess servicing as additional principal to noteholders. Turboing creates overcollateralization (OC) by reducing the note balance more quickly than the collateral balance.

Pro Rata Payments

Sometimes auto transactions provide for simultaneous pro rata payment of subordinate classes with the sequential payment of senior classes. Typically, the trust must first attain a target level of credit enhancement (typically overcollateralization) before it may pay subordinate classes pro rata.

Frequently, the trust must reach target

enhancement before paying pro rata.



In addition, sometimes if the trust fails to meet specified levels of performance or credit enhancement, it must cease paying pro rata. It must revert to sequential payment and the subordinate classes mature last in the structure (this event happened in certain MMCA transactions, for example).

Cash Reserve Accounts

Most auto transactions have a cash reserve account. Some trusts do not fund the reserve account up front, or only partially fund the reserve account up front. For partially funded or unfunded accounts, the trust attains the required balance by paying the excess spread generated by the pool into the cash reserve account. It typically takes several months to reach the required balance. (Excess spread is cash flow that remains after the payment of all deal expenses. Expenses include the coupon, servicing, trustee fees and credit losses.)

Once the reserve account is fully funded, the trust must maintain a defined minimum balance. The minimum is usually a specified percentage of the pool balance, or a fixed dollar amount. The trust replenishes the under-funded reserve account by retention of excess spread.

Structure Standardization

Programmatic issuers of prime, nonprime, and subprime autos typically establish a standard credit structure for their securitization transactions. Structural consistency facilitates investors’ analysis for future transactions. Structures will vary from issuer to issuer and from sector to sector. However, the credit enhancement ranges will be roughly similar for lenders within a sector (prime, nonprime, or subprime). Credit enhancement differences will be based on the historical collateral performance and recent trends, seasoning, and other factors.

One of the factors that differentiates a transaction is a trigger. The purpose of a trigger is to fortify the structure if the collateral fails to meet defined performance levels. Prime auto loan transactions do not typically contain any triggers. Wrapped subprime/nonprime transactions may contain performance triggers.

Triggers that block the trust payout of excess spread from the trust may have negative liquidity repercussions for the seller. Americredit experienced a significant liquidity squeeze several years ago as a result of being unable to obtain the excess spread from many of its securitizations. Auto triggers typically require an increase in the cash reserve account if the trust fails to meet defined performance standards. The trust’s excess spread is the source of the funds for the reserve account increase.

Sometimes the trust attains additional credit enhancement through turboing excess spread to achieve a target level of overcollateralization. It is necessary to examine each transaction for its specific structural nuances.

Excess spread typically funds the reserve account.

Wrapped deals may contain performance triggers.



Alternative Structures

Prefunding Structures Some issuers choose to prefund (borrow in advance of contract origination). Market conditions may be especially attractive, or the issuer may need to securitize a critical mass of loans. In an ABS transaction, prefunding typically covers up to about six months of future originations, but generally terminates within two to three months.

A trust escrow account holds the prefunded proceeds pending origination of the receivables. The trustee may release the escrow account upon substitution of qualified receivables. The new receivables must be consistent with the underwriting standards in the rest of the pool and may have other restrictions, such as maximum maturity and minimum coupon, so that the integrity of the receivables pool is maintained. In the event that the originator fails to assemble sufficient receivables, the trust returns the funds in the escrow fund to the investors as a prepayment

Soft Bullet Structures A soft bullet structure is viable for firms that are able to issue asset backed commercial paper. In lieu of a conventional amortizing deal, the novel alternative structure provides for a soft bullet repayment of the term notes. Two of the top three auto companies issued this alternative auto structure in late 1999 and early 2000. We describe the cash flow mechanics here.

The trust simultaneously issues a series of term notes and asset-backed commercial paper notes. The same receivables pool collateralizes both series. The trust cash flow is first directed to the commercial paper notes, and all principal collections are applied against reduction of the commercial paper notes. The targeted maturity of the first series of term notes coincides with the expected reduction of the first series of commercial paper notes to zero (based on historical prepayment speeds). In order to repay the first series of term notes when due, the trust issues a new series of ABS commercial paper, and repays the term notes in a bullet with the proceeds. The sequence begins again until the deal is fully repaid (see Figure 7).

Figure 7. ABS Commercial Paper Notes Absorb Principal Amortization and Allow Soft Bullet Term Notes Structure

Soft bullet notes

ABS Commercial Paper

ABS C.P. notes

0 mos. 6 mos.

Amortization absorbed by ABS commercial paper notes

Soft bullet taken out by re-issuance of ABS commercial paper

Soft bullet notes

ABS Commercial Paper

ABS C.P. notes

0 mos. 6 mos.

Amortization absorbed by ABS commercial paper notes

Soft bullet taken out by re-issuance of ABS commercial paper

Source: Citigroup.

The trust deposits prefunded proceeds into escrow.

A soft bullet structure debuted in 1999.



The ABS commercial paper (ABCP) notes carry a floating rate coupon, while the collateral possesses a fixed rate coupon. In order to mitigate the interest rate risk, the rating agencies require the trust to execute an interest rate swap. The swap caps the rate that the trust will pay for the initial and subsequent ABCP notes. Typically, the interest rate swap provider is senior to the note holders. If the swap were to terminate, the commercial paper interest rate will automatically become a fixed rate payable by the trust and the trust will not be permitted to issue future commercial paper notes.

The structure insulates the term note holders from variability in payment speeds. If the collateral pays faster than expected, the trust may reduce the commercial paper notes to zero before the bullet term note is scheduled to mature. In such a case, a designated account will accumulate collections from the receivables pool until the term note matures. The accumulated funds in the account and proceeds from new commercial paper issuance will repay the term note.

If the collateral pays more slowly than expected, and the commercial paper is still outstanding upon maturity of the soft bullet, the trust may still issue a new series of commercial paper notes to retire the term notes. The two series of commercial paper notes are then simultaneously outstanding, and principal collections repay the two series of commercial paper on a sequential basis.

The notes will extend if the trust is unable to sell commercial paper to retire that class on its targeted distribution date. The maturity dates for the bullet classes are “targeted” dates. A disruption in the commercial paper market, for example, might cause such an extension. While this is extremely unlikely, the trust would then apply principal collections pro rata to the commercial paper notes outstanding and to the class next targeted for maturity. The trust would attempt to get back on track with the bullet structure for the next class. However, if two consecutive bullet maturities are not paid in full, the structure begins sequential amortization, with pro rata application of principal against the bullet notes and any outstanding commercial paper.

A swap provides interest rate protection.

Speed variability is not problematic.



Credit Enhancement

Auto structures are typically senior/subordinated, with a cash reserve account. Sometimes they are overcollateralized, sometimes they are wrapped. The amount of required credit enhancement depends on the expected losses and other factors. Prime loans have the least enhancement and subprime loans have the greatest enhancement. We show the credit enhancement for selected issuers in Figure 8.

Figure 8. Comparative Credit Enhancement for Selected Issuers Issuer Ford GMAC (CARAT) Toyota Long Beach Acceptance Capital One Auto Americredit Transaction 2002-D 2005-1 2003-B 2005-A 2005-B -SS 2005-1Structure Senior/sub/OC Senior/sub Senior/sub FSA wrap Senior/sub Senior/Sub/OCTriple-A classes 7.50% 8.00% 3.50% 23.50% 31.25%Single-A classes 4.50% 4.00% NA 16.50% 13.25%Triple-B classes 2.50% 2.50% NA 8.00% 6.50%Not rated or double-B classes OC + Excess spread 1.50% NA 3.50%c,d OCInitial Overcollateralization 0.50% 1.00% NA 0.00% 14.50% 5.75%Target Overcollateralization 1.0% curr./0.5% init.a 1.50% NA 24.00% 17.50%Initial Cash Reserve Account 0.50% 0.50% 0.50%b 1.25% 2.00% 2.00%Target Cash Reserve Account 0.50% 0.50% non dec. Na 1.25% non dec. 2.00% Capped at initial a Alternate target OC is balance of delinquent receivables in excess of 91 days. b In lieu of a reserve account, Toyota Motor Credit (TMCC) provides a revolving liquidity note. In the event that TMCC's short-term unsecured debt rating falls below defined levels, TMCC must fund the reserve account with cash. In addition, the required amount increases to 0.50% of the cutoff balance or 3.50% of the outstanding balance if the annualized chargeoffs or 60-day delinquent accounts exceed specified levels. c Demand note held by seller. Trust also issued a Class R note evidencing the right to excess cash flow arising from the receivables. d lCredit enhancement grows to 10% of current or 2.25% of initial principal amount. Sources: Prospectuses and Moody’s.

Credit Enhancement Varieties

Credit enhancement comes in a variety of formats, mixes, and amounts. The most common types of credit enhancement are as follows:

Cash Reserve Account. Minimum cash reserve account requirements typically range from 0.25% to 2.0%. At cutoff, the cash reserve account may be fully, partially, or not funded up front. If the trust commences with a zero-balance reserve account, it attains the required balance over time, sourced from excess spread.

The reserve account source of funds is generally an up-front cash deposit made by the seller, or deposited from the trust bond proceeds. A reserve account that is not fully funded up front will withhold excess spread over time. It typically would take three to six months to fully fund the reserve account, depending on the amount of excess spread and the required amount.

The trust documents will enumerate the permissible investments for the cash reserve account. Some structures allow the use of cash investments in additional receivables. (That generates a higher yield than money market investments). This, however, creates additional risk that some of those receivables will incur losses.

Excess Spread. Excess spread provides extra credit enhancement for the trust in addition to subordination, cash reserve account, and OC (if applicable). Excess spread is the cash flow remaining after payment of the transaction expenses. The formula for excess spread is:

Pool yield – (servicing fee + coupon interest expense) = Excess Spread available to absorb losses

The reserve may be fully, partially, or not funded

up front.

Excess spread provides additional

credit enhancement.



Prime auto loan excess spread generally ranges from 1.50% to 3.00% after losses. Excess spread on subprime auto loans is generally higher, between 4% and 7% p.a. after losses. Higher excess spread from a subprime pool provides a larger cushion to absorb the greater credit loss variability than that of a prime pool. The seller may receive payment of the excess spread in any month it is not required in the deal.

On a risk-adjusted return basis, cash from the excess spread varies over the life of a transaction, depending on the timing of losses (loss curve) and prepayments, especially of higher coupon loans.

Subordination. Trusts create a cash flow queue, and some classes of investors are superior to other classes. The most senior investors receive interest and principal prior to more junior investors. Creating classes of debt in rank-order within the trust provides credit enhancement.

Investors and the seller/servicer generally share ownership of the trust. Each owns a proportional undivided interest in the auto loans, and the seller’s interest is subordinate to the senior interest in its right to receive payments. The trust may sell subordinate classes in the public market to third-party investors and reduce its “subordinate interest.” (Please refer to the Cash Flow section of the report).

“Turbo” Payments. The trust may accelerate repayment of the senior classes by the application of excess spread to the senior tranches. The effect of this is that the remaining subordinated class as a proportion of the outstanding deal is greater than the original structure. (Ford uses the turbo structure, for example.)

Overcollateralization. Overcollateralization is an excess of collateral in relation to ABS notes issued. The collateral pool assets are greater than the trust liabilities by a certain margin. Overcollateralization is an alternative form of subordination. The larger asset balance generates significant cash flow in relation to the trust debt service requirements. Overcollateralization provides an extra cushion to absorb losses.

Triggers. Few prime auto transactions contain triggers. Typically only wrapped nonprime or subprime transactions include triggers. Triggers are trust provisions requiring certain defined actions if the pool performance deteriorates. Usually the trust must increase the credit enhancement after hitting a trust trigger. Triggers are usually tied to levels of pool delinquency and losses. Sometimes they are benchmarked to cumulative loss levels at certain points during the pool life.

Triggers generally require the spread account to build to a certain level by trapping excess spread. The worse the pool performance, the higher the required cash reserve account level. The specific trigger details are typically based on a variance to historical pool performance.

Alternatively, triggers may sometimes require that the trust “turbo” excess spread in lieu of building the cash reserve account. Turboing accelerates payments to the senior classes relative to the rest of the trust. That acceleration reduces the senior classes more rapidly than the rest of the trust. Therefore, the subordinate classes (or the overcollateralization) increase disproportionately as a percentage of the transaction.

Trusts create a cash flow queue, and some

investors are superior to others.

OC is another form of subordination.

Few prime auto deals have triggers.

Turbo triggers increase enhancement.



Monoline insurance. The trust may utilize third-party insurance to guaranty repayment of auto loan (and other) ABS. Subprime and nonprime auto issuers frequently utilize monoline insurance to “wrap” (guaranty) their deals. Monolines are mostly triple-A rated insurance companies with the sole purpose of guaranteeing payment of principal and interest to investors. In addition to a repayment guaranty, many monolines indemnify investors against bankruptcy risk in the event that the court did not uphold the structure’s bankruptcy-remoteness.

It is important to understand precisely what the monoline guarantees and when the guaranty is valid. Some monolines guaranty full principal and interest when due, while others guaranty timely interest and ultimate principal.

Rating Agency Credit Enhancement Requirements To establish the required credit enhancement, the rating agencies take into consideration the legal, collateral, and structural aspects of the transaction. The agencies examine the collateral performance history and loss curves and other quantitative and qualitative factors. S&P provides the credit loss multiple guidelines for required credit enhancement shown in Figure 9. Moody’s does not provide specific guidance multiples.

Figure 9. Required Credit Enhancement — S&P Guidelines for Auto Credit Loss Coverage S&P Rating Loss MultipleAAA 4–5 times base case lossesAA 3–4 times A 2–3 times BBB 1.75–2 times BB 1.5–1.75 times

Source: Standard & Poor’s Rating Criteria.

The agencies do not give full credit for excess spread as credit enhancement. Credit for excess spread depends on the transaction structure, seasoning of the pool, and other factors. The structural features include the presence and amount of a cash reserve account, and whether the structure turbos excess spread. Credit also depends on the timing of expected losses — back-ended losses require greater credit enhancement. In unseasoned pools, S&P gives credit for excess spread as long as the cash reserve account fully funds within a few months into the transaction.

Monoline insurance provides a third-party irrevocable guaranty.



Other Risk Factors

Servicing Risk Servicing risk addresses the concern that the servicer will not survive the full life of the securitization in order to service the collateral. Servicer failures have caused problems in some ABS transactions in the past. Sectors affected include subprime autos, HELs, and manufactured housing. The unsecured ratings of the seller/servicer are one of the factors to consider in evaluating servicing risk. We show senior unsecured debt ratings for selected servicers in Figure 10.

Figure 10. Unsecured Ratings for Selected Auto Companies Company Moody’s Outlook S&P Outlook Americredit B1 Stable B+ Stable BMW Finance NV A1 Stable NA NA Capital One Financial Baa3 Positive BBB- Positive Ford Motor Credit Baa3 Negative BB+ Negative GMAC Ba1 Negative BB Negative Honda Auto Finance A1 Stable AA Stable Household Finance Co A1 Positive A Stable Hyundai Motor Co. Baa3 Stable BB+ Positive Long Beach Acceptance NA NA NA NA Mitsubishi Motor Corp Ba3 Neg CCC+ Negative Nissan Motor Acceptance Baa1 Stable BBB+ Stable Toyota Motor Credit Aaa Stable AAA Stable Triad NA NA NA NA USAA Capital Corp. Aa1 Stable AAA Stable Volkswagen A3 Stable A- Stable Western Financial Bank B1 Stable BB- Positive

Source: Bloomberg.

There are several points to consider in relation to servicing risk:

Seller/Servicer Financial Stability and Access to Liquidity Seller/servicers are not always investment-grade companies, and the investor should spend some time to understand the servicer. Access to a continuing source of liquidity and capital is especially important. Finance companies need liquidity in order to continue to originate new business. This is most critical in a high portfolio growth environment where the servicer has negative cash flow (originates more contracts than mature in any period). Funding requirements may exceed the cash flow produced by the servicer’s managed portfolio. Therefore, understand the seller’s access to capital and liquidity.

Servicing Intensity of Collateral Delays in transferring servicing may prove costly if the collateral is “high maintenance.” Subprime accounts, or the “underserved” market requires frequent and intensive attention. Investors need to factor in the competence and experience of the servicer and the adequacy of the resources devoted to servicing. Higher losses and a delay in servicing transfer should be factored into stress tests run by investors.

Access to liquidity is important.



Third-Party Servicing, If Necessary Collateral that is generic and unexceptional is the easiest and quickest for a third-party servicer to take over. If the collateral is not garden-variety or if the servicer is noninvestment grade, there may be more difficulty finding an appropriate servicer, and resulting transference delays. For exceptional situations, investors may consider having backup servicing on the transaction. A “hot” backup servicer runs a parallel set of books and is able to assume servicing on little notice. Hot backup servicers are generally found mostly in the private markets.

Underwriting and Collections Risks Consistent underwriting standards convey an ability to duplicate historical pool performance. Changes in underwriting therefore could warrant some caution about portfolio quality. It is useful to examine and understand the servicer’s underwriting and collections policies to determine the credit profile of the collateral pool.

Prospectuses generally discuss the collateral, underwriting, and collections policies. New and greater disclosures will be required subsequent to December 31, 2005, pursuant to the SEC’s new Regulation AB. Some of the Regulation AB details require clarification, and we do not cover that in this report.

Delinquency and Loss History

Delinquency and net loss history is generally available for the managed pool, not for static pools. Some issuers report static pool information on a Web site or on Bloomberg.

Delinquencies arise from obligors that fail to make a payment by the due date. A percentage of delinquencies will most likely become uncollectible, and delinquencies provide an early warning signal for future credit losses. It is important to examine the stability and level of delinquencies and net losses and their trends in order to evaluate the sufficiency of credit enhancement versus expectations.

Collections policies govern when and how often the servicer contacts the borrower and when the servicer will charge-off an account. Higher risk receivables typically require more frequent contact. The servicer typically describes its policies and practices to manage the collection process.

New Versus Used Mix

New vehicles depreciate more quickly than used vehicles, but generally better hold up their collateral value over time. In addition, a higher quality obligor generally purchases a new vehicle over a used vehicle. Most auto lenders grant credit for the purchase of used as well as new vehicles. Prime lenders tend to finance more new than used vehicles. The typical proportion of new vehicles in a prime auto pool ranges from 60%–100%. Subprime lenders tend to finance mostly used vehicles (new vehicles range from 0% to 40% typically).

Minimum, Maximum, Average Loan Balance

It is useful to examine the distribution of loan balances. Concentrations in large loan balances may result in higher severity of losses for those loans. Changes in any of the averages from prior deals may signal a change in underwriting policies.

Garden variety collateral is easiest to take over.

Examine the underwriting and

collection practices.

Subprime loans require more attentiveness.



Seasoning, Weighted Average Maturity, and Mix of Contracts

Seasoned loans perform better than unseasoned loans. Seasoning refers to how long ago the servicer granted the loans. The prospectus also discloses the remaining term to maturity. The contract maturities are usually well distributed to provide a consistent cash flow stream.

Underwriters have been granting longer maturity contracts — up to 72 months and sometimes even 84 months in recent years. The longer maturity makes the payment more affordable. On the other hand, the collateral loses value as it ages, and the collateral is further underwater later in the contract age. However, no evidence to date indicates that longer maturities are resulting in greater losses. Loss curves appear to be more back-ended (see Figure 6).

Geographic Diversity

A geographically well-balanced pool is desirable. Large regional or state concentrations might invite further inquiry into the laws or loss patterns peculiar to that region. The rating agencies will generally require extra credit enhancement to compensate for any unusual geographic concentrations.

Other Information

The following information is generally not provided in prospectuses, but investors may have opportunities to ask for this information at issuer meetings or on-site visits:

➤ Average FICO score, range, and mix of scores. This provides a general idea of the obligor quality of the pool to compare against other issuers. The minimum FICO score acceptable to the servicer provides insight into the range of obligor quality.

➤ Average advance on vehicle value. This is more important for sub-prime lenders. Higher losses are generally experienced on high advance rates. Most lenders will generally advance no more than 105% to 110% of NADA wholesale value, plus tax, tags and insurance.

➤ First payment defaults (for subprime issuers). First payment defaults should be negligible. This should be a low number, even for subprime lenders. First payment defaults should be in a range of 1% or less.

➤ Extension policies. Extensions can lengthen the average life of the pool so many transactions cap the permitted length and amount of extensions in a pool. An extension is where the servicer permits the borrower to take one or more payment holidays. In order to avoid disguising credit problems, some servicers require that the contract be current before granting an extension.

➤ Underwriting decision model — automated or subjective. Many lenders have risk-based proprietary decision-making systems. Understand the lenders strategy and history. Insight into policy exceptions is also valuable.

Seasoned loans perform better.

Geographical diversity is desirable.



Payment Speeds

Auto speeds are generally very stable. Auto loans are not sensitive to refinancing if interest rates decline. Unlike the home mortgage market, auto owners cannot refinance their used vehicle at a better interest rate if rates decline. Autos are depreciating assets. Therefore, the cost of refinancing a used auto is greater than the cost to finance a new vehicle. (See Figure 3, which shows new and used vehicle interest rates reported by the Fed.)

The age of the vehicle, condition, and the frequency of replacement are factors related to auto turnover. Because auto loans are short assets (generally 36 to 72 months), the effect of variability of speeds on cash flow is minimal. However, differences in speeds can make a significant difference in yield, particularly in a steep yield curve environment. Payment speeds are generally expressed as an asset-backed speed (ABS). Transactions generally pay between an ABS of 1.4 to 1.7. ABS is calculated as the number of contracts repaying in the current month in relation to the original contract number.

Prime Auto Speeds Prime autos typically price at a 1.5 ABS, which is the average lifetime speed. Auto speeds exhibit some variability within the lifetime of the securitization. Our examination of a major prime auto lender shows that its speed ranges from 0.20 to 2.0 ABS during its life. Its average speed registered about a 1.5 ABS.

The speeds in Figure 11 (2001 through 2004 vintages of a major prime lender) start out slowly, rise, peak, and then taper off later in the life of the transaction. The minimum reported monthly asset backed speed on the curve was 0.20, and the maximum was 1.87. The trend line shows the average speed for the 2001 vintage is approximately 1.5 ABS. More work needs to be done regarding speeds, and this pattern suggests that a CPR ramp might be a better way to evaluate auto speeds.

Figure 11. Average Prime Auto Asset Backed Speeds for 2001 Through 2005 Vintages

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

1.82.0

1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41Months From Issuance

ABS

(%)

Average 2001 Average 2002 Average 2003Average 2004 Linear (Average 2001)

Prime Auto Speeds

Source: Citigroup.

Prime autos frequently exhibit a speed ramp, and average 1.5 ABS.



Subprime and Nonprime Auto Speeds The asset backed speeds for nonprime and subprime auto collateral are issuer specific. There is no standardized pricing speed for all issuers. These speeds typically run slightly faster than prime auto loans, reflecting the higher credit loss levels and the loss curve. Generally, most nonprime and subprime issuers price at approximately a flat 1.7 or 1.8 ABS. However, subprime and nonprime asset backed speeds exhibit variability during the life of the loan, similar to prime loans.

We show the average asset backed speeds for a major subprime issuer for its 2000 through 2005 vintages in Figure 12. The 2005 vintage has very few data points, and consequently reflects the noise of such few observations. Asset backed speeds show a wide variation, ranging from -0.12 to 2.7. We attribute negative speeds to high levels of delinquency and extensions, offsetting expected cash flows. The curves mostly show elevated speeds at the beginning, corresponding to the credit loss cycle.

The trend line for the 2002 vintage shows a lifetime asset backed speed of 1.7. The speed fluctuations also suggest that it might be preferable to use a CPR ramp to evaluate the speeds.

Figure 12. Average Asset Backed Speeds for a Major Subprime Auto Issuer (2000 Through 2004 Vintages)

Subprime Speed Curve

-0.50

0.00

0.50

1.00

1.50

2.00

2.50

3.00

1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41 43 45 47Month of Transaction

ABS

(%)

Average 2000 Average 2001 Average 2002Average 2003 Average 2004 Average 2005Linear (Average 2002)

Source: Citigroup.

Subprime and nonprime auto speeds are

deal specific.



To Call or Not To Call — Auto ABSs’ Early Call Option

Fully two-thirds of the 16 auto issuers we examined exercised the call option within one or two months of the eligible exercise date in the period we examined. Administration and timing may have caused those insignificant delays. Most lenders do exercise the call, even in an unfavorable interest rate environment (where interest rates are higher than the callable transaction), although some did not exercise in the period that we examined. Call behavior did not depend on whether the seller was investment grade or not.

Americredit has consistently called its transactions reasonably close to the exercise date, while Chase (even with a 5% call on transactions prior to 1998) did not. Some issuers that generally exercise at 10% have (on occasion) allowed a few months to elapse after the eligible call date. MMCA, Onyx Auto, and WFS Financial did not consistently clean up at the eligible exercise date during that time.

Auto ABSs typically have a call option when the collateral pool has a 10% balance (some older transactions had 5% call options) and frequently price to the expected call option. If not called, autos can extend as much as 12 to 15 months to maturity.

The choice of whether or not to call an auto ABS issue is not clear-cut, as in the corporate bond world, where the call exercise is purely interest rate driven. From a true sale perspective, a seller may not represent that it will make the optional call. The decision to call an auto ABS transaction layers in other factors, such as the cost of the seller’s capital tied up in the structure (reserve account and residual interest) as well as the administrative costs of servicing. The higher cost of servicing a small pool balance is frequently used as the rationale to clean up outstanding auto ABSs, regardless of interest rates. Programmatic issuers will frequently call a transaction and roll the collateral into a new issue, which will enable it to distribute its fixed costs over a larger base. The cost of capital encumbered in the structure is more difficult to quantify.

The ability to free up seasoned collateral may be a factor in the call decision as well. The call exercise is practical because it enables the seller to include both seasoned and unseasoned collateral in a new issue transaction that refinances the called one. Seasoned collateral is predictable and helps to reduce variability in the cash flow in the new issue. The inclusion of seasoned collateral generally has some value in pricing and in determining the required credit enhancement for a new issue. The rating agencies frequently require less credit enhancement for seasoned collateral.

Admittedly, investment-grade sellers may have sufficient seasoned receivables already on balance sheet for inclusion in a new issue. Investment-grade sellers frequently do not securitize the majority of their receivables in the securitization market, preferring to diversify their sources of funding. On the other hand, noninvestment-grade sellers may be able to use the seasoned collateral to their advantage in a new issue. Noninvestment-grade servicers frequently rely on the securitization market to a greater extent than investment-grade servicers. Consequently, the noninvestment-grade servicer may not have much seasoned

Most trusts exercise the call within one to

two months.

The call decision is not purely interest

rate driven.

The ability to free up seasoned collateral

could be a factor in the call decision as well.



collateral on balance sheet. By the same token, the noninvestment-grade seller may not have as much financial flexibility to execute the call. However, as long as it is able to refinance, it may be motivated to call to free up the seasoned collateral.

Purely from an interest rate perspective, the rational seller will call a transaction if the cost to refinance is less than the coupon it is paying on the currently callable transaction. The flip side is that high current rates compared to original issuance will not motivate the trust to exercise the call. However, if the administrative and capital costs of continuing to keep the auto ABS issue outstanding outweigh the lower coupon benefits, the trust is likely to exercise the call, regardless of interest rates. Even though this call theory is a long-standing principle of the auto ABS market, the current interest rate environment has kindled investor fears about the call exercise of auto ABSs.

Some trusts have not consistently exercised the call option. We examined three-year single-A auto ABS yields from 1994 to the present. The subordinate investors are the most exposed to the extension risk if the issuer fails to exercise the call. Because sales of triple-B auto ABSs in the market are limited, we selected single-A autos for the study. We examined the yield of current single-A autos compared to the yield three years prior to the eligible call date (see Figure 13). A negative number on the graph shows that current interest rates are lower than the coupon set three years earlier (providing positive incentive for call). A positive number on the graph shows that current three-year single-A yields are greater than the yields three years earlier (a disincentive for call).

Figure 13. Three-Year Single-A Call Incentive, Jul 97–Aug 05

(5.7) (4.7) (3.7) (2.7) (1.7) (0.7) 0.3 1.3Jul 97

Jan 98

Jul 98

Jan 99

Jul 99

Jan 00

Jul 00

Jan 01

Jul 01

Jan 02

Jul 02

Jan 03

Jul 03

Jan 04

Jul 04

Jan 05

Jul 05

(%)

Call Incentive: (+) More Expensive to Refinance /(-) Cheaper to Refinance

Source: Citigroup.

The decision to call is influenced by the extra

cost of servicing a small asset base.



Currently, seasoned callable single-A transactions are unattractive to call. Current rates are higher than three years ago. The data in Figure 13 examine the period from 1994 to present, but the graph begins at 1997 because it compares the 1997 yields to those in 1994. It is cheap to call the issues with negative spreads (current rate lower than original rate), and unattractive to call those with positive spreads (current rate greater than original rate). The 1996–1998 issues were expensive to call. Therefore, sellers’ call actions for the 1996 through 1998 issues are relevant. We examined major trust call behavior during that time.

The historical call actions for the 16 auto issuers we examined show a lack of consistency in seller call practices. A handful of sellers consistently exercised the call at the 10% balance during that period, which was unattractive for the issuer from an interest rate perspective. Most issuers allowed one to four months to elapse before exercising the call. Some issuers allowed the trust to extend the call exercise by as much as 15 months. We show selected issuers in Figure 14.

Figure 14. Call Actions by Selected Auto Trusts for 1996 Through 1998 Transactions Trust Call Exercise Actions Long Beach Acceptance No missed calls Summit Acceptance (acquired by Capital One) No missed calls Toyota Auto Receivables No missed calls

Capital Auto Receivables (GMAC) Issued no retail deals from 1996 to 1998.

Americredit Automobile Receivables Trust One-month extension on 1996-A, no other failures to exercise call promptly Ford Credit Auto Owner Trust Two-month extension for 1997-B,one-month for 1998-A Harley Davidson Eaglemark Motorcycle Trust One-month extension on all 1997-1 through 1998-3 deals Honda Auto Receivables Grantor Trust One-month extension on 1997-A and 1998-A Household Automotive Revolving Trust I Two-month extension on 1998-1 Hyundai Auto Receivables One-month extension on 1998-A Nissan Auto Receivables Grantor Trust One-month extension on 1997-A and 1998-A

WFS Financial Owner Trust One- or two-quarter extensions on 1996-A to 1996-D (quarterly pay, 5% call option) Chase Manhattan Auto Owner Trust Three- to seven-month extensions on 1996-A through 1998-C (5% call options) Premier Auto Trust (Chrysler) Five-month extension for 1997-1; two-months for 1998-1; one-month for 1996-2

MMCA Auto Owner Trust 12- to 15-month extension on 1997-1 and 1998-1 Onyx Acceptance Two- to 15-month extension on 1996-1 to 1998-C

Sources: Moody’s performance reports and Citigroup.

Sellers’ actions go a long way to building investor confidence. Among the 16 trusts we examined, three — Long Beach Acceptance, Summit Acceptance (acquired by Capital One), and Toyota — have perfect track records during that time period. Each of these trusts exercised the call promptly on the 10% balance. An additional seven (44%) of the trusts — Americredit, Ford, Harley Davidson, Honda, Household, Hyundai, and Nissan — exercised the call within one or two months of the eligible exercise date. Three trusts — Chase, Chrysler, and WFS Financial — exercised within three to seven months of the eligible date. Finally, two issuers — MMCA and Onyx — ran the trust almost to maturity, extending the call exercise date by some 12 to 15 months. GMAC issued no retail transactions in that time period. GMAC’s CARAT priced some of its transactions to maturity.

The 1995 to 1998 issues were expensive to

exercise the call.

Three trusts have a perfect track record.



Other Auto ABS Products

Dealer Floor-Plan Loans In order to sustain a loss on dealer floor-plan transactions, three events must simultaneously occur: (1) dealer default; (2) manufacturer default; and (3) a decline in vehicle value. Contingent recourse to the manufacturer (an inventory buyback agreement) provides a belt-and-suspenders approach to well-structured and well-collateralized transactions. Dealer floor-plan loans have three sources of cash flow:

1 Repayment from the vehicle dealers, derived from retail sales;

2 Inventory liquidation in secondary market (trust has a perfected security interest in vehicle collateral and proceeds); and

3 Manufacturer inventory buyback if the dealer defaults.

Dealer floor-plan receivables are very high quality. Mostly new vehicles are included in the collateral pools. Because dealer floor-plan loans have very low default rates and fast payment rates, the manufacturer’s buyback contingency is remote. If the buyback were to be exercised, the repurchased vehicle inventory has significant value. The manufacturer should be able to easily monetize the value by selling the inventory to another dealer. (However, a manufacturer bankruptcy would probably negatively affect the inventory value.)

Definition

The practice of lenders that provide loans to a manufacturer’s dealer for the purpose of financing inventory pending retail sale is called dealer floor-planning. The vehicle manufacturers widely utilize dealer floor-planning. Other manufacturers have been known to utilize this financing form as well, from furniture manufacturers to equipment manufacturers. Focusing on the auto industry, this financing form provides working capital for vehicle dealers financing new and used inventory in the showroom and on the dealer lot before selling inventory to retail customers. Floor-plan lenders may be the vehicle manufacturer, a bank or finance company, and the loans are generally made to franchised new vehicle dealers.

Structures

Dealer floor-plan structures look very much like credit card ABS with a revolving period and a bullet maturity. Vehicles and proceeds secure the loans, and the trust generally requires interest only until the vehicle is sold. The trust applies the dealer repayments to purchase new dealer receivables during the revolving period. The securitization vehicle is a master trust and numerous transactions may share the same collateral pool. The advance rate on the loans may include the wholesale vehicle price plus destination charges. The dealer repays the loan upon sale of the vehicle. Credit losses are low, diversification is generally good and payment rate is high for floor-plan receivables.

Transactions mirror the dynamics of the underlying receivables with a bullet or soft bullet maturity. As vehicle inventory turns over fairly quickly, payment rates are typically very high. Losses are low on dealer floor-plan transactions, and inventory

Three simultaneous events must take place

to default — a low probability.

The structures resemble credit cards.



diversification is generally good. There are typically concentration limits for used vehicles as well as dealer concentration limits. Investors should be aware of the consolidating trend in the auto dealer business that may affect the diversification of these pools. Investors are typically well protected, however, by the concentration triggers in the structure.

Credit Enhancement

The floor-plan credit structure is typically senior/subordinated, sometimes with a cash reserve account. There are generally concentration limits and triggers that are similar to credit cards. Floor-plan structures frequently have a minimum payment rate trigger, as well. The payment rates from dealers are typically higher than payment rates in credit card trusts, minimizing the potential amount of time the investor would be exposed to severity of loss if the transaction were to hit the early amortization trigger. Just-in-time inventory systems advances have minimized the amount of time vehicles need to sit on dealer showroom floors. Consequently, payment rates are very high and have increased industry-wide in recent years. We show a typical vehicle dealer floor-plan structure in Figure 15.

Figure 15. Dealer Floor-Plan Credit Enhancement for Two Ford Transactions (In Percent) FORDF 2004-1 FORDF 2001-1Subordinated Class B Notes 3.29 3.29Subordinated Seller’s Interest 6.10 6.10Reserve Fund 0.00 0.36Accumulation Reserve Account 0.26 0.26

Total Triple-A Credit Enhancement: 9.65 10.01

Source: Citigroup.

The principal balance of the financed vehicle is typically 100% of the invoice price and principal payments are generally due on the earlier of the sale or other specified period. In the event the dealer becomes insolvent, the manufacturer will usually repurchase the vehicles from the defaulted dealer at 100% of the invoice price. The manufacturer’s buyback obligation adds some credit linkage to the structure to the manufacturer’s unsecured ratings. If the financial condition of the manufacturer deteriorates, there could be a negative impact on the recoveries on the collateral. Therefore, there is a higher probability that the dealer would default on its obligations.

The credit quality and payment rates are generally of the highest degree in auto manufacturer pools. We show comparative trust collateral characteristics for the three largest US manufacturers in Figure 16.

Figure 16. Comparative Dealer Collateral Characteristics FORD 2005-1 SWIFT XII DCMOT 2005-ATrust Balance (Dollars in Billions) $19.20 $34.50 $12.30 New/Used Percentage 96%/4% 89% /11% 88%/12%Average Payment Rate 33.10% 31.80% 43.90%

Source: Citigroup.

Structures are typically senior/sub.

Payment is due upon vehicle sale.



Dealer Floor-Plan Credit Losses

Credit losses have historically been very low among auto dealers. Credit standards are high for dealers to qualify for financing. The follow-up monitoring of dealers’ financial conditions and inventory management is strict. In addition, the captive finance companies take swift remedial actions as necessary. When a dealer goes bankrupt, the captive finance company (usually in conjunction with the manufacturer) repossesses the inventory. The manufacturer normally has the right and sometimes the obligation to repurchase the new vehicles, resulting in no loss to the captive finance company.

We show trends in dealer floor-plan credit losses for the industry from 1996 to the present in Figure 17. Our industry average includes net losses reported by BMW, DaimlerChrysler, Ford, GMAC, Nissan, Mitsubishi, and Volkswagen.

Figure 17. Auto Industry Dealer Floor-Plan Credit Losses, 1996–Present

0.00%

0.05%

0.10%

0.15%

0.20%

0.25%

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Perc

ent (

%)

Industry Average Credit Losses

Sources: Moody’s performance reports and Citigroup.

Inconsequential industry credit losses ranged from 0.00% to 0.12% between 1996 and 2004. High credit standards and rigorous auditing standards help to suppress dealer credit losses. The industry credit losses popped above the trend in 2005, to 0.22%, because losses isolated to Mitsubishi Motor Corporation’s (MMC) dealer floor-plan master trust (MMCAM) distorted the average. MMCAM reported a 5.23% credit loss in March 2005, its first loss ever. Other auto manufacturers have reported zero dealer floor-plan losses thus far in 2005.

High payment rates are another sign of strong asset quality. Payment rates are very high for auto dealers. The payment rate indicates how quickly the dealer turns over its inventory and receives payment on the receivables. From 1996 to 2005 to date, payment rates ranged from 40% to 50%. Payment rates stand at the lower end of that range from 2003 onward, because of industry competition.

Nonetheless, dealer payment rates contrast sharply with credit card payment rates, which are much lower. From the investor’s viewpoint, this high payment rate shows that it takes only a few months to pay off the entire portfolio, minimizing the amount of time the investor is exposed to severity of losses (see Figure 18).

Credit losses have been low due to strong credit underwriting and

follow-up auditing.

MMCAM caused the recent rise.

High payment rates are another sign of strong

asset quality.



Figure 18. Industry Average Payment Rates, 1996–Present

0%

10%

20%

30%

40%

50%

60%

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Perc

ent (

%)

Industry Average Pay Rates

Sources: Moody’s Performance reports and Citigroup.

Contingent Recourse in Dealer Floor-Plan Structures

Some linkage to the auto manufacturer’s financial condition should be taken into account, because manufacturer support influences the dealers’ vitality. If the manufacturer is struggling financially, it will in all likelihood negatively affect its dealers’ sales and profitability. Some interdependent relationships include warrantees, production of spare parts, marketing, promotion, and access to credit at attractive rates.

Moody’s downgraded MMCAM in February 2005 from AAA to Aa2 as a result of continuing uncertainty surrounding the MMC franchise in the United States and its negative operating cash flow. (MMC’s sales declined 37% in 2004.) Moody’s noted that although portfolio performance remained within the expected range, “the strength of MMC’s franchise is important to the credit quality of the floor-plan receivable notes.” S&P kept MMCAM’s rating at triple-A. If the US manufacturers’ financial conditions continue to deteriorate, investors need to keep the ratings linkage in mind.

Manufacturers Buyback Obligations — A Residual Value Indemnity

When a dealer gets into trouble (bankruptcy), the captive finance company generally repossesses the inventory. Prior to repossession, the lender works with the dealer to try to resolve the dealer’s difficulties. However, the lender’s priority is to minimize any potential loss. The manufacturer normally has the right and sometimes the obligation to repurchase the new vehicles from the captive at the full book value, resulting in no loss to its finance company. The manufacturer is then able to realize the value from the repossessed inventory by selling it to other dealers.

Manufacturer Debt — Staggered Maturities

The major US auto manufacturers have distributed their dealer floor-plan debt maturities so that they are well staggered. Individual transactions have ranged from $1 billion to $2.4 billion. General Motors’ last SWIFT transaction was a seven-year floating rate transaction with classes rated from triple-A to double-B. Many dealer floor-plan transactions are floating rate, but there are some fixed rate ones as well.

There is some ratings linkage to the

unsecured entity.

The manufacturer frequently has an

inventory buyback obligation if the

dealer fails.

Debt maturities are well staggered.



We show the outstanding dealer floor-plan indebtedness and expected maturities for major US auto manufacturers in Figure 19.

Figure 19. US Auto Manufacturers Dealer Floor-Plan ABS Outstandings and Maturities, 29 Apr 05 (In Dollars) Issuer Amount ($) Expected MaturitySWIFT (GMAC)

2004-A9 2,124,000 May 072003-A8 2,132,000 Sep 082004-A8 632,000 Sep 082004-A10 2,371,585 Sep 092005-A11 2,375,825 Feb 12

SWIFT total 9,635,410

FORDF (Ford) 2001-2 2,000,000 Jul 062004-1 3,000,000 Jul 07

FORDF Total 5,000,000

DCMOT (Daimler Chrysler) 2002-A 2,000,000 May 052002-B 1,000,000 Nov 052004-A 1,000,000 Jan 072004-B 1,000,000 Aug 072005-A 1,700,000 Apr 08

DCMOT Total 6,700,000

Sources: Bloomberg and Citigroup.

Relative to their asset bases, the major US manufacturers have not aggressively securitized their dealer floor-plan book. Aggregate dealer floor-plan exposures are not detailed in 10-K reports. GMAC’s disclosure, for example, aggregates all wholesale assets, which includes equipment and other commercial assets. The Federal Reserve Bank’s quarterly G-20 report, which surveys major US auto manufacturers, reports a 50% wholesale securitization rate for the industry. That securitization rate is higher than for industry retail auto receivables, which stands at 35%. Those low rates imply that there could be significantly more securitizations possible from the manufacturers’ unencumbered retail and wholesale assets. If they were to step up their securitization rates, the additional supply could have a significant impact on spreads.

Fleet Financing for Auto Rental Companies ABS fleet financing for auto rental companies offers the widest spreads in the auto sector. This is because of the significant linkage to the operating risks of the underlying auto rental companies. The sector underwent significant stress in 2001. Several auto rental companies reorganized under bankruptcy protection and failed to observe the early amortization triggers in their ABS transactions (ANC Rental and Budget Auto, for example). Ultimately the ABS trusts did not default and the rental companies emerged from bankruptcy. All classes of ABS investors were unimpaired. Today most fleet finance transactions utilize third-party monoline insurance guarantees. ABS fleet financing structures are a method to finance auto inventory for daily auto rental car companies.

Fleet financing offers the widest spreads in

the sector.



The fleet finance structures partially rely on a buyback guarantee from auto manufacturers (generally several manufacturers sell vehicles to the trust.). The rating agencies will typically not give any buyback credit for noninvestment-grade manufacturers. The trust purchases the inventory and leases it to the auto rental company. Inventory and receivables under the lease secure these structures. The rental company is the sole obligor, so there is significant operating company credit risk linkage. Repayment, generally in three to five years, is due in a bullet or soft bullet.

Auto rental companies are the single largest global customers for the auto manufacturers. The rental companies enter into multiyear commitments to purchase vehicles from auto manufacturers. In return, the auto manufacturers’ buyback agreements provide a form of residual value insurance for the rental companies. The manufacturers are contractually obligated to purchase vehicles back from the rental companies at an agreed upon residual value, subject to a minimum holding period. The vehicles covered by the repurchase commitment are called “program vehicles.” We show how the manufacturers’ residual value commitment functions in the auto rental industry in Figure 20.

Figure 20. Auto Manufacturers Have Significant Residual Value Commitments to Auto Rental Industry

Auto Manufacturer SPV

Auto Rental Company

Biggest customers are auto rental companies

Owns vehicles and leases to operating company

Guarantees residual value for program vehicles

� Leases vehicles from SPV

� Depreciates to guaranteed residual value

Asset Backed SecuritySecured by:� Inventory, receivables and� Mfg’s buyback commitment

Auto Manufacturer SPV

Auto Rental Company

Biggest customers are auto rental companies

Owns vehicles and leases to operating company

Guarantees residual value for program vehicles

� Leases vehicles from SPV

� Depreciates to guaranteed residual value

Asset Backed SecuritySecured by:� Inventory, receivables and� Mfg’s buyback commitment

Source: Citigroup.

A special purpose vehicle (SPV) will purchase the vehicles from the manufacturer and lease them back to the auto rental company. The ABS transaction is secured by a lien on program and nonprogram (no manufacturer repurchase commitment) vehicles, and proceeds owed under the lease agreement between the SPV and the rental company.

Inventory, receivables, and manufacturers’ buyback

guarantees secure the trust.



The cash flow comes from two sources:

1 Lease payments due from the auto rental company (the sole obligor); and

2 The sale of vehicles to the manufacturer under its program vehicle commitment or sale of the vehicles in the used car market.

The lease payments cover the cost of carrying the vehicles and a depreciation charge. The depreciation charge reduces the vehicle book value to the residual value guaranteed by the manufacturer.

Credit Enhancement Credit enhancement is typically subordination, overcollateralization, and a letter of credit. Market transactions in recent years typically utilize monoline insurance guarantees. The credit risk of the transaction depends on the ability of the rental company to make payments under the lease and the manufacturer’s ability to honor its obligations. We show the credit enhancement for an AESOP Funding (Avis Rent A Car System) transaction in Figure 21.

Figure 21. AESOP 2003-5 Funding Structure and Credit Enhancement Liquidity Support Reserve Account/Letter of Credit 2.25% Dynamic Overcollateralization: Program Vehicle OC Requirement 13.5% Nonprogram Vehicle OC Requirement 19.0% Nonprogram Vehicle Limit 25%

Surety Provider XL Capital — Timely Interest/Ultimate Principal

Source: Citigroup.

Budget Auto Rental and ANC Rental (Alamo and National) reorganized under bankruptcy protection in 2001. Bankruptcy was an immediate early amortization event under the triggers in their ABS debt agreements. The trusts had the right to immediately turn the vehicles back to the manufacturers and demand payment under the manufacturers’ repurchase obligations. However, the bankruptcy court overrode the pooling and servicing agreements and early amortization failed to take place. However, the trust assets remained isolated from the bankruptcy estate. Debtor-in-possession financing subsequently repaid the ABS investors in full.

These events were important precedents in the ABS market, in that the bankruptcy judge overrode the governing trust documents. The failure to demand payment under the trusts’ early amortization trigger rights presented a smoother cash flow solution for the auto manufacturers. The auto companies avoided having to repurchase entire fleets at once.

Manufacturer Contingencies Major US auto manufacturers have significant contingent commitments to the auto rental industry. They are obligated to buy back used vehicles at guaranteed residual values. This buyback commitment helps the auto rental companies to manage their residual value exposures. As long as the manufacturers have estimated the residual values accurately, this exposure should be manageable. The used vehicle market has good depth and the manufacturer or the trust should be able to sell the vehicles in the used car market at the residual value price or better. This ability to sell in the used vehicle market provides another source of liquidity for the trust.

Typical transactions have monoline insurance.



What is the extent of manufacturers’ contingent exposures? To answer this question, we examined the five major auto rental companies: Cendant (Avis and Budget brands), Hertz (wholly owned by Ford), Enterprise Auto (privately held company), Vanguard Car Rental (Alamo and National brands), and Dollar Thrifty Auto. Most of their ABS transactions are not public.

Cendant purchases its vehicles primarily from General Motors and Ford. Hertz purchases the majority of its fleet from Ford (51%). Alamo National purchases 61% of its vehicles from GM. Each of these companies utilizes the ABS market to finance major portions of their fleet inventory (see Figure 22).

Figure 22. Auto Manufacturer Repurchase Commitments for Major Auto Rental Companies (Dollars in Millions) Auto Leasing Company Rental Assets at 31 Dec 04 ABS Debt Auto Manufacturer Suppliers Cendant (Avis/Budget) 7,046 5,935 GM and Ford — proportions undisclosed Hertz 9,123 6,650 Ford — 51% of fleet Enterprise NA NA NA Vanguard (Alamo National) NA 3,200 GM — 61% of fleet Dollar Thrifty 2,267 1,710 Daimler Chrysler = 85% of fleet

NA Not Available. Sources: 10-K reports and Citigroup.

Auto Leases

Risks and Structure

Auto lease ABSs offer attractive returns but greater risks than auto loan ABSs. Spreads are greater than auto loan ABSs because the investor assumes residual value risk in addition to credit loss risk. Credit losses are typically very low, and speeds are more stable than the auto loan market.

Some captive finance companies and banks have used the securitization market to finance their vehicle lease portfolios. Examples are BMW, GMAC, Nissan, Toyota, and Volkswagon. Leasing now accounts for a substantial proportion of all US vehicle sales — ranging from about 35% to 45%. Closed-end leases are the most common consumer vehicle leases. In a closed-end lease, the lessor retains ownership of the vehicle. The consumer pays some up-front costs — a capitalized cost reduction (a small down payment equivalent), taxes, registration, and other fees and charges.

For example, a 36-month lease payment may cover about 40% of the vehicle cost. The lessor sets the vehicle residual value to 60% of the original cost at the lease maturity in 36 months. The lease payment will amortize 40% of the vehicle cost and will also include charges for interest, taxes, and other fees. At the lease maturity, the customer has the right to purchase the vehicle for 60% of the original vehicle cost or to return the vehicle to the lessor.

Auto Leasing Residual Value

A significant risk in a lease-backed transaction is the residual value risk. The risk exists only if the lessee returns the vehicle to the lessor. If the lessee can sell the car for more than residual value, many lessees will exercise their option to purchase the vehicle at the residual option price. However, some lessees always prefer to drive a new vehicle and will return the car even if there is a profit on the residual. If the

Lease returns are attractive.

Residual value risk is a consideration.



market price is less than the residual, lessees will usually return the vehicle to the lessor. Lessees that terminate the lease prior to maturity are responsible for the residual value. Therefore, the leasing company will only be at risk for residual value exposure if the leases go to the full term and the customer returns the vehicle.

Lease Vehicle Turn-Ins

Leased vehicles that are returned to the lessor are called “turn-ins.” Vehicle turn-ins creates the possibility for the trust to incur a residual value loss on disposal of the vehicle. In the early 1990s, turn-in rates as a proportion of managed lease pools were low — in the 30% range among major vehicle manufacturers. In recent years, turn-in percentages have increased, ranging from 60%–70%.

Trusts can minimize the impact of turn-in risks through various structures:

➤ Proper initial residual value setting. A conservative residual valuation method reduces the risk that the residual value will produce a loss at the lease maturity. Sometimes trusts will use a more conservative lease valuation for the securitization than in the underlying lease contracts. (For example, BMW Vehicle Lease Trust has employed this conservative method.) The Auto Lease Guide (ALG) or internal risk systems are frequently used to establish conservative residual values.

➤ Staggering maturities of leases along curve. Staggering the lease maturities along the curve removes the residual value concentration risk that would otherwise be present. The trust can distribute the turn-in risks throughout the transaction by effective maturity management.

➤ Effective vehicle disposal management. Effective vehicle disposal management practices may improve the residual values. Some manufacturers have established innovative practices by offering vehicles on Web sites. In addition, they may ship vehicles to the most attractive auto auction locations to realize a better price.

➤ Vehicle model diversification. The inclusion of numerous vehicle models within a trust diversifies the residual value risks. The residual value of certain models may suffer, but a portfolio of vehicles reduces that risk.

Auto Lease Credit Losses

Credit losses are low on vehicle leases because the criteria are very stringent to obtain a lease. Credit losses on leased vehicles are much lower than even prime auto loans and are not a great risk in leased transactions. We show cumulative losses and 60-plus day delinquencies for a major auto leasing company in Figure 23. The net cumulative losses include both credit losses and residual value losses. Net cumulative losses reached 1.44% at month 42 of the transaction. Seriously delinquent receivables were minor.

Effective disposal management mitigates

the residual risk.



Figure 23. Cumulative Losses for Major Auto Leasing Company

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

1.8

1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41

Months of Transaction

Perc

ent (

%)

60+ Days Del. Cum. Loss %

Source: Citigroup.

Leasing Losses Frequency and Severity

Moody’s approach to rating lease-backed transactions looks at the frequency and severity of losses for sizing credit enhancement. Turn-ins address the frequency component of the risk, where the manufacturer may incur a loss on the residual in reselling the vehicles. Severity of loss is addressed by whether or not the vehicle manufacturer incurs a loss on the returned vehicle in resale. Losses on residual valuations have been mixed in recent years. Many banks and manufacturers have experienced higher turn-ins and higher losses on the resale of vehicles. However, healthy credit enhancement protects the higher turn-ins and expected losses in ABS lease securitizations.

Auto Leasing Structure

A special purpose, bankruptcy remote vehicle called a “titling trust” purchases and owns the vehicles. The vehicle trust, which sells notes to investors, owns a beneficial interest in a designated portfolio of leases and vehicles in the titling trust, also known as a special unit of beneficial interest (SUBI). The vehicle lease trust owns an interest in the SUBI, not on the leases and vehicles directly. It is the SUBI and the rights associated with it that are securitized. Ownership of the leased vehicles or lease receivables are not part of the securitized trust estate but remain in the titling trust.

This lease structure is unique because most ABS transactions provide for a direct lien on cash-generating assets supporting the notes. The SUBI is a claim on the designated portfolio of contracts and leased vehicles and gives the securitization trustee a right to cash payments received from these assets. The SUBI interest is analogous to a security interest in the common stock of a corporation, not a debt claim on its assets. This equity claim potentially exposes the trust to claims from the Pension Benefit Guaranty Corporation (PBGC), which we will discuss later in this report.

We show a generic organizational chart for typical auto lease trust structures in Figure 24. The issuing vehicle lease trust owns units of beneficial interest in the leases and vehicles, not direct ownership of the vehicles. There is no UCC filing to designate a lien holder interest in the vehicles, because the titling trust owns the vehicles.

Healthy credit enhancement protects

against the risks.

The trust has a SUBI interest in the assets.



Figure 24. Overview of a Typical Auto Lease Transaction

Senior NotesCertificate Holders

Vehicle Lease TrustTRUST ISSUER

Auto Leasing LLCTransferor

Manufacturer Limited PartnershipUndivided Trust Interest Beneficiary

Retains UTI

Titling Trust

Acquires and owns vehicles Leases vehicles to customers Retains residual

values

Secured by pledge of:�Vehicle SUBI certificate�Lease SUBI certificate�Reserve fund

Two-step transfer

UTI sells:�Vehicle SUBI certificate�Lease SUBI certificate

Titling Trust issues:�Vehicle SUBI certificate�Lease SUBI certificate

Captive Finance Company Services leases

Manufacturer sells vehicles to titling trust

Manufacturer owns majority interest in UTI

Senior NotesCertificate Holders

Vehicle Lease TrustTRUST ISSUER

Auto Leasing LLCTransferor

Manufacturer Limited PartnershipUndivided Trust Interest Beneficiary

Retains UTI

Titling Trust

Acquires and owns vehicles Leases vehicles to customers Retains residual

values

Secured by pledge of:�Vehicle SUBI certificate�Lease SUBI certificate�Reserve fund

Two-step transfer

UTI sells:�Vehicle SUBI certificate�Lease SUBI certificate

Titling Trust issues:�Vehicle SUBI certificate�Lease SUBI certificate

Captive Finance Company Services leases

Manufacturer sells vehicles to titling trust

Manufacturer owns majority interest in UTI

Source: Citigroup.

The trust may structure the vehicle leases as sequential cash flows (most common) or as pass-throughs. Credit enhancement looks very similar to auto loan transactions, although credit enhancement is greater to cover potential residual value losses. There is generally a cash reserve account, subordination or overcollateralization, and excess spread. Several deals have incorporated dynamic credit enhancement where the cash reserve account is nondeclining. This builds credit enhancement over the life of the transaction, as the cash reserve account is a greater proportion in relation to the declining balance of the security.

Some issuers have chosen to cover the residual value risk with residual value risk insurance from a highly rated insurer, and to assign it for the benefit of the SUBI interests. Residual value insurance is not commonly used in ABS structures.

Pension Benefit Guaranty Corporation Risks to Lease Transactions

Auto lease transactions are potentially vulnerable to the imposition of a lien by the Pension Benefit Guarantee Corporation (PBGC) that could supercede the ABS investors’ position. ERISA mandates that the PBGC put a lien on up to 30% of the collective net worth of a company whose plan has been taken over by the PBGC in the case of Chapter 11 reorganization. ERISA also mandates a lien under the following additional circumstances: (1) if termination of the defined benefit pension plan occurs; (2) if the plan is deemed to be distressed by the PBGC using facts, figures, and other qualitative factors; and (3) if failure to make required payments occurs. Under ERISA/IRS rules, if a plan is more than 90% funded, no additional deficit funding is required. However, in any year when a firm falls below 80% of the plan benefit obligation, it is required to make a sizeable deficit contribution of as

Sequential structures are the most common.

Auto lease ABSs are vulnerable to a

superceding PBGC lien.



much as 30% of the total deficit amount until the funding status is repaired.3 In the case of a Chapter 11 reorganization, the employer’s obligation is for the full, underfunded amount of any plan taken over by the PBGC.

Auto lease transactions do not have a direct lien notation on the vehicle title and lease proceeds. The ABS indenture trustee has a perfected security interest in the SUBI certificate. This certificate represents the beneficial ownership interest in the lease assets (lease and vehicle certificate of title). The only way to perfect a security interest in the titled assets is to record the lien of the ABS indenture trustee or an acceptable “collateral agent.” This is why it would be possible for the PBGC to preempt the security interest of the ABS investors. Under certain circumstances, the PBGC could perfect a security interest on the vehicle titles and lease proceeds, but the action would be administratively cumbersome and the PBGC would have to pay filing fees for each title.

Until 2003, the rating agencies were comfortable with the titling trust structures and investors’ position as a SUBI certificate holder. The rating agencies had deemed the unfunded pension risks of seller/servicers as small for SUBI structures. Auto leasing structures are a well-established sector of the ABS market. Going forward, the rating agencies are considering incorporating some ratings based triggers on a case-by-case basis into certain auto lease transactions.

S&P placed eight auto leasing companies’ ABS lease transactions on CreditWatch Negative in May 2003 in reaction to the rising risks of unfunded pension liabilities, coupled with the “distress terminations” of pension plans for companies in bankruptcy. Upon further examination of the unfunded pension obligations of those entities, it affirmed the ratings of most of the leasing companies.

Most pension plans of affected entities do not represent a significant risk to the cited transactions. The issuers’ unsecured rating is one measure to evaluate the unfunded pension plan risk. In general, noninvestment-grade companies would be more vulnerable than investment-grade firms to bankruptcy and other distress risks. However, unsecured ratings are not particularly sensitive to pension risk measures. Investors should also examine other pension risk measures such as the plan’s pension benefit obligation in relation to its assets, the trend of employer contributions, total unfunded liabilities as a percent of earnings, and other factors.

General Motors Novel Structure Eliminates PBGC Risk General Motors priced its first ever auto lease transaction in April 2005 with a novel ABS structure that eliminates the PBGC risk. The structure establishes GMAC as a secured party.

Each leased vehicle in the trust is titled at origination in the name of Vehicle Asset Universal Leasing Trust (VAULT). GMAC is the first lien holder on all of the leased vehicle titles. VAULT’s purpose is to hold and facilitate the transfer of the legal title

3 For more details on underfunded pension plans, refer to our corporate strategists comprehensive report Credit Risks Associated with

Underfunded Pension Plans, Dennis Adler, Richard Salditt, Robert Waldman, and Mike Kender, Citigroup, November 18, 2002.

The rating agencies are considering adding some

rating-based triggers on a case-by-case basis.

Most leasing entities do not bear significant

PBGC risk.

GM’s deal eliminated the PBGC risk.



of the leased vehicles acquired by GMAC, establishing it as a secured party instead of a holder of an equity interest in a SUBI trust.

Vicarious Tort — No Longer a Risk Federal legislation (HR 3) eliminates vicarious tort liability for auto rental companies. It was signed into law on July 28, 2005. Prior to this federal legislation, certain states (Maine, New York, and Washington DC) possessed unlimited vicarious liability damage laws. This liability discouraged auto rental companies from operating in those states. Vicarious tort liability held that a rental company is vicariously liable for damages and injuries resulting from the operation of the rental vehicle by the driver or the lessee, subject to statutory limits for bodily injury and property damage.

The risk of vicarious liability related to the state in which the vehicle was used, not exclusively the state of the lease domicile. The legal philosophy behind vicarious tort is that a party of authority can be held liable for the negligent acts of the other, even though the party of authority was not in itself negligent.

The business model for auto rental companies has evolved from direct ownership of cars by the rental company to a situation where the rental company controls the operation of the vehicles, and an asset backed securitization trust owns the title to the vehicles and leases them to the rental companies. Under the old legislation, the trust could potentially have vicarious tort liability. Carrying an appropriate level of liability insurance mitigated that risk. Under the new legislation, trusts share the same immunity from vicarious liability as the rental companies.



Appendix

List of Prime, Nonprime, and Subprime Lenders Our periodic Auto Performance Report evaluates industry credit performance by sector — prime, nonprime, and subprime auto lenders. We show the 15 lenders included in Citigroup’s indexes by sector in Figure 25.

Figure 25. Auto Lenders by Market Segment Prime Nonprime SubprimeBMW Long Beach Acceptancea AmericreditDaimler Chrysler Onyx Capital OneFord UAC HouseholdGMAC WFS Long Beach Acceptance (pre-2004)Honda JP Morgan Chase Nissan Toyota

a 2004 and later vintages. Source: Citigroup.

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