The process of auto loan securitization involves packaging auto loans together and selling them to investors. The securitization process essentially helps convert an asset that is not liquid into a security that can be traded or held. This process could affect your auto loan after it is originated by the lender.
Holding Loans
In the past, the banking industry held onto loans after they were originated. When you would go to the bank and get a loan for the purchase of a car, after it was originated, the lender would service it. You would make your payment directly to the lender and if you had a problem, you would talk to the lender. With securitization, the lender now has the ability to group your loan together with other similar loans and sell that package to investment banks.
How It Works
Banks write a relatively large number of auto, mortgage and personal loans, which can then be packaged into securities by interest rate and risk. These securitized loans are then sold to investors and investment banks. Then when consumers make payments on their loans, this money goes to the investors as a return for their investment. If low-risk loans are used, this type of investment can be relatively safe for investors.
Issues for Investors
While auto loan securitization can be attractive for investors, it can also lead to some issues. For example, when interest rates in the market fall, it often leads to consumers refinancing their loans. When this happens, the loans in the group are paid off and the investors stop earning returns on their investment. When the economy is down, it can also lead to repossessions. When this happens, the loans no longer earn interest, which negatively impacts the investors.
Rating Agency
To make this process work, rating agencies become involved. Entities like Standard & Poor's and Moody's issue ratings on securitization vehicles. To do this, they will analyze the underlying risk of the loans in the group. Then the rating agency issues a relative risk rating for the security. For example, when the security has a AAA rating attached to it, it appears to be very safe to investors. Securities with lower ratings have higher interest rates attached.
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