Last Updated: June 2, 2014

Automobile Loans
1. Characteristics of Automobile Loan Receivables
Automobile loan receivables are securitized often as receivables with low default rate and highcreditworthiness, although they depend on credit policy of originators such as their screening because thereceivables are against individuals with their purpose of borrowing being clear.
The characteristics of these receivables and pool of automobile loan securitization are the following:· Their degree of dispersion is high and impairment rate of pool owing to occurrence of default isrelatively stable, because automobile loans, which are receivables against individuals in many smalllots, are the underlying assets.
· As the debtors choose cars to be purchased in the light of their ability to repay, and they have a clear
purpose of borrowing, i.e., owning a car, their intention to repay debt is considered high relative to thegeneral unsecured borrowings. As a result, default rate of receivables is relatively low.
· On the other hand, competition among companies engaging in automobile sales finance centering on
non-banks is fierce to a certain degree in a situation where domestic car sales in units have been
declining due to market saturation. As a result, loan interest rates are relatively low. (Proportion ofexcess spread that can be used as internal credit enhancement facility is low.)· There are many cases in which repayments are made combined with bonus payments, because theamount of borrowings (amount of receivables) is relatively large; therefore, these receivables have acharacteristic that their cash flows in a specific month (recovery amount in the month of bonuspayments) become large. (In securitization scheme, it is necessary to consider an approach to thecommingling risk that is different from the commingling risk in securitization of normal money claims
with equal monthly payments in many cases.)
JCR outlines whereabouts of risk and points of concern in rating for securitization products ofautomobile loan receivables below.
2. Risk of Automobile Loan Receivables(1) Risk from Prepayment
There are always incentives for the debtors to repay their debts in advance, because they repay theoutstanding loans in a lump-sum along with replacement with a new car, and amount to become
unnecessary for the future interest payments by repayment will become large for them simply owing tothe large amount in the claims. Therefore, it is necessary to make a cash flow analysis on the assumptionthat prepayment may occur to a certain degree. Concerning risk that cash flow (recovery) from the entire
pool of automobile loan receivables is reduced from the initially assumed amount (dilution) owing to the1/6
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lump-sum repayment by the debtors, JCR examines and makes an analysis using historical data, etc.
Although the automobile loans are shown and executed with fixed interest rates, receivable data
after execution themselves are transferred as cash flow with principal and interest payments combined,
and at the time of prepayment, the debt is cleared by a certain calculation method, called“shichi-hachibun” method, and only remaining principal is recovered.
As there are also needs for partial prepayments from the debtors, it is necessary to make an analysis,
keeping in mind the originator’s approach to these partial prepayments, records in the past and treatment
in securitization.
In cash flow analysis of securitization products, reduction in the interest income in the future due tothe increasing prepayment and impact of reduction in the principal amount due to the defaults on thereceivables during the securitization period as a result of the loan principal recovery in advance byprepayment are considered. JCR studies pattern of occurrence of prepayment including an extreme casescenario (no occurrence or occurrence at an extremely high proportion) on the assumption thatcreditworthiness of debtors of the securitization pool may becomes worse faster than lapse of time,
because good debtors are in a layer in which debtors prepay their debts, referring to historical data, andexamines the worst case scenario for the impairment of pool of receivables.
(2) Dilution Risk Associated with Cancellation etc.
Though less often than general installment sales receivables, automobile loans are cancelledsometimes and for various reasons. While cancellations by cooling-off system cannot be applied topurchase of passenger vehicles in general, in cases including flaws found in cars purchased, recoveries
may not be credit for that part as a result of the debtors’ assertion for defense for suspension of payment.
Although repurchase by originator, as a breach of “representation and warranty”, is scheduled torespond to the dilution owing to these cancellations under the scheme, such risk will come to the surface
when originator fails and can’t repurchase it. It is necessary to examine whether or not there is any
structural problem in cause for the dilution risk owing to these cancellations beforehand.
In case of handling products with a variety of differences in quality for individual products as in thecase of used cars, for example, in particular, there are chances that occurrence of dilution risk will behigh temporarily, if there is a problem with sales technique at the dealers. The efforts to diversify thedealers by reducing the ratio of the same dealers to the entire pool to below a certain degree and theestablishment of seasoning period as an eligibility requirement of loans for securitization are generaltreatments to deal with such risk under the securitization structure. In the interview with the originator atthe time of execution of securitization, the conditions of the originator’s screening and monitoring forthe dealers are items to be verified. Even if there is no malicious intention on the part of the dealers, it isnecessary to take notice of measures for exclusion of the customers (debtors) who has a purpose of cheaton the cars or borrowed monies because of the large amount of monies. When JCR thinks that there areproblems that can have an impact on the future performance in the records of defaults and the accidents
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in the past anyhow, JCR studies addition of stress.
Even if the originator properly conducts management and screening for the dealers, occurrence ofcancellations cannot be avoided because it is difficult to entirely exclude frauds or accidents in thefuture at such dealers. Given this possibility, JCR considers that little concentration of dealers in thepool of receivables is desirable in order not to affect the pool of receivables even if large-scale
cancellations occur under the securitization structure.
In many cases, the cancellations due to the frauds can be discovered in the early stage of thesecuritization after signing a contract, and records of a certain number of repayments lead to low
cancellation rate in general. Taking the records of the number of payments (called seasoning in general)
into the eligibility requirements for receivables can be considered effective in reductions of dilution riskof receivables owing to the cancellations in the automobile loan receivables securitization.
One other example of dilution risk is that in the case when debtors have filed against the originatorprocedures for claims for refund of overcharged interest payments, there will be chances that payments
for the automobile loan receivables will stop or that such debtors may offset such refund with
automobile loan receivables in the course of such claims.
(3) Points to Consider in Case Where There are Special Products
Although full payout method with equal monthly payment combined with bonus payment within
the term is general in the automobile loan repayment, type of loans, which can reduce monthly amountof repayment by setting residual value of the vehicle after a certain period of time (about three-yearperiod), is popular. There may be a different risk in such cases from the risk in the general loan in termsof recovery of the loan at the termination. JCR studies whether or not there are product types of loansthat require assumptions of cash flow and its risk, which are different from the assumptions in generalcase; and in that case, JCR studies what kind of risk JCR should consider additionally in the stress test,
referring to the past data.
3. Calculation of Credit Enhancement Level
As the automobile loan receivables are in general well-diversified in many small lots, expected loss
amount owing to defaults on the underlying receivables is calculated by stress test based on approach ofmany small lots using the law of large numbers.
(1) Analysis of Receivables of the Population and Receivables of the Securitization(i) Calculation of Percentage of Credit Losses, etc.
Percentage of credit losses, prepayment rate and cancellation rate are calculated using historical
data on the receivables of the population. As for the percentage of credit losses in the case of
securitization, JCR calculates such percentage of credit losses for each securitization based on
definition of default under each securitization structure.
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(ii) Analysis of Composition Ratio of Receivables of the Population and Receivables of theSecuritization
JCR understands characteristics of the pool of receivables of the population and pool ofreceivables of the securitization from data by composition ratio on the pool of receivables of thepopulation and on the pool of receivables of the securitization, and also refers to the comparisons
between the two when determining scaling factor of stress. The following items of attributions ofdebtors and receivables are considered factors which may in some cases affect the potential default
rate, and it is necessary to make a comparative analysis of the two pools to determine whether or notthere exist any differences to be considered in the assumption of the securitization pool’s impairment
rate.
(a) Sex and Age(b) Residence of debtors(c) Dealer(d) Car Type and Manufacturer(e) New Car or Used Car(f) Interest Rate Applied(g) Amount of Individual Receivables(h) The Number of Payments Already and the Number of Remaining Payments(2) Determination of Base Rate
JCR determines a base rate for verification and analysis of movements of each parameter(percentage of credit losses, prepayment rate, and cancellation rate) from historical data of thereceivables of the population. With the average value of historical data being a basis, JCR determines a
final base rate for each parameter, taking into consideration past trend, outlier, or macro data on themarket, and also qualitative factors such as items confirmed by the due diligence meeting (credit policy,billing system, debt collection procedures, transfer to the managed claims or guidelines for write-offs)
entirely, and then incorporating these considerations into the analysis.

(3) Stress Test
JCR calculates next required subordination amount for the target rating after generating stressed
percentage of credit losses, prepayment rate and cancellation rate for the cash flow expected during theterm. There are multiple cases for the levels after the addition of stress, and they include a level of thebase rate multiplied by a constant, or the one with the standard deviation of historical data multiplied bya constant being added to the base rate. JCR adopts an appropriate level for each case. JCR determines ascaling factor of stress in consideration of qualitative factors such as attributes of receivables of the4/6
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population and the receivables of the securitization, taking 3.5 times for AAA rating and 2.5 times for A
rating as standard scaling factors for securitization of pool of many small receivables againstindividuals.
(4) Commingling Risk
JCR deals with the commingling risk in general by setting the required subordination amount to thelargest amount to be expected to become non-recoverable if the originator as servicer becomes bankrupt
at any time after start of the securitization. JCR determines the required subordination amount inaccordance with the way of transmitting recoveries and its schedule by confirming scheduled cash flow
for the receivable and also paying attention to the amount of prepayment, because automobile loan
receivables include claims with unequal monthly payments such as payments combined with bonus
payments or amount of prepayment.
There are cases in the securitization structures where the commingling risk is dealt with by aprovisional payment of recoveries by the originator and others. In such cases, JCR examines to whatextent the commingling risk is reduced for each securitization product, because each has a different
provisional payment date, paying-in date from debtors, schedule for delivery of recoveries.
In case where the originator meets certain requirements, JCR allows the originator not to set a
subordinated beneficial interest amount for the commingling risk initially required until infringement oftrigger by setting up a trigger for the commingling.
(Please refer to "Commingling Risk Pertaining to Securitization Products.")(5) Cash Reserve (Liquidity Facility)
It is necessary to reserve funds as cash reserve to be required in a period till recoveries are credited
to the SPV or trust again after the servicer transfers its collection operation to the backup servicer when
the servicer goes into a situation where it cannot conduct said operation as usual due to default or someother reasons.
The length of period required to resume crediting of recoveries or recovery status in a situation
where the servicer needs to be replaced under a securitization structure in general will be affected by theindividual factors including stand-by condition (hot, warm or cold) of backup servicer, its capacity tohandle, the number of debtors, and whether or not there are any arrangements that can make theinheritance from the originator’s normal management and collection system easy.
Although it is expected that disorder at the time of the taking over the debt collection operationfrom the originator is small in the automobile loan relative to the general unsecured loans to individuals,
because the creditworthiness of the claims is high, this does not change JCR’s view that it is necessary
to give consideration to the contingency plan from the time of securitization execution.
JCR has a policy as a general rule in rating the automobile loan receivables as in the case of other
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money claims that backup servicer should be set up from the very beginning of the securitization. As foran originator with a certain level of a rating given, however, JCR admits that a backup servicer is notselected at the beginning.
(Please refer to "Backup Servicer in Securitization.")
4. Monitoring
In principle, JCR monitors the performance of underlying assets and reviews the rating as long as arated debt is outstanding. JCR conducts monitoring on a constant basis to check the performance ofunderlying assets, including the monthly default rate; changes in the subordination ratio; and capabilitiesof parties to the structure to carry out their duties. When conducting the review of credit ratings, JCR
reexamines, as necessary, the base rate and other rating assumptions in light of the performance ofunderlying assets and economic conditions and analyses cash flows based on these assumptions with due
consideration given to the remaining term of securitization products. Rating review is held on a regularbasis, as well as on an ad hoc basis as necessary in case of a sudden change or event.
Because of the possibility of human or mechanical error as well as other factors in the information herein, JCR makes no representation orwarranty, express or implied, as to accuracy, results, adequacy, timeliness, completeness or merchantability, or fitness for any particular purpose,with respect to any such information, and is not responsible for any errors or omissions, or for results obtained from the use of such information.
Under no circumstances will JCR be liable for any special, indirect, incidental or consequential damages of any kind caused by the use of any suchinformation, including but not limited to, lost opportunity or lost money, whether in contract, tort, strict liability or otherwise, and whether suchdamages are foreseeable or unforeseeable. Information herein is statements of opinion, and not statements of fact as to credit risk decisions orrecommendations regarding decisions to purchase, sell or hold any securities such as individual bonds or commercial paper. JCR retains all rights
pertaining to this document. Any reproduction, adaptation, alteration, etc. of this document, is prohibited, whether or not wholly or partly, without
prior consent of JCR.

Japan Credit Rating Agency, Ltd.
Jiji Press Building, 5-15-8 Ginza,Chuo-ku, Tokyo 104-0061, Japan
Tel. +81 3 3544 7013, Fax. +81 3 3544 7026

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