What it means
The mechanics are straightforward. A lender sells a large pool of car loans to a separate legal entity, usually a trust, and the trust issues certificates to investors that entitle them to the cash those loans produce.
Lenders do this to recycle capital. Selling the loans turns a long stream of future repayments into cash today, which can be lent out again, and it moves the loans off the lender's own balance sheet so less capital has to be held against them.
Investors are protected by structure rather than by a single guarantee. Certificates are usually issued in layers, with senior layers paid first and junior layers absorbing losses first, and the pool is often larger than the certificates issued so there is a cushion of extra loans.
The main risks are credit and timing. Borrowers default, which eats into the cushion, and borrowers also repay early when they trade a vehicle in, which returns money to investors sooner than planned and cuts the interest they expected to earn.
The servicer matters as much as the loans. Someone has to collect payments, chase arrears and repossess vehicles, and if that firm fails the trust must appoint a replacement, which is why rating agencies look closely at servicing quality.
In everyday use the term has broadened. Many people now say CARS loosely for any car loan securitisation, although the name originally belonged to a specific family of certificates issued in the 1980s.
In practice
Real-world examples.
Example
The finance arm of a car manufacturer securitises $600,000,000 of loans so it can keep writing new finance deals without raising fresh equity. The cash released funds roughly four months of new lending at its current run rate.
Example
A pension fund buys the senior layer of a car loan securitisation because it wants short-dated, highly rated paper with predictable monthly cash flows. The trade-off it accepts is that unexpected early repayments will hand its money back sooner, at a time when reinvestment rates may be lower.
Example
An analyst reviewing a bank notices that much of its reported lending growth comes from loans it originates and immediately sells into securitisation trusts. She adjusts her view of the bank's earnings quality, because fee income from selling loans behaves very differently from interest income on loans held.
Formula
Calculation
Over-collateralisation = pool balance - certificate balance, and monthly pass-through = collections - servicing fee - trustee and administration fees
A trust buys car loans with a total balance of $480,000,000 and issues certificates of $450,000,000. The over-collateralisation is 480,000,000 - 450,000,000 = $30,000,000, which is 30,000,000 / 480,000,000 = 6.25% of the pool. In one month the servicer collects $12,000,000 of principal and interest. The servicing fee is 1% a year on the pool balance, so 480,000,000 x 0.01 = $4,800,000 a year, or 4,800,000 / 12 = $400,000 for the month, and trustee and administration costs are $100,000. Investors therefore receive 12,000,000 - 400,000 - 100,000 = $11,500,000 that month.Case study
Seen in the real world.
Fenwick Motor Credit is an illustrative, fictional lender that funded its entire car loan book with short-term bank lines. When those lines were cut at renewal, the business could not finance new lending even though its existing loans were performing well.
Its treasurer arranged a securitisation instead. A trust bought $300,000,000 of loans, issued $280,000,000 of certificates in three layers, and Fenwick retained the most junior layer so investors could see that it kept the first loss. The retained piece tied up capital but made the senior layers far easier to place.
The illustrative outcome was a funding structure matched in length to the loans themselves, which is the problem securitisation solves best. Fenwick still carried credit risk through the piece it retained, and the treasurer was careful to describe it that way to the board rather than presenting the loans as sold and forgotten.
Watch out
Common mistakes.
- Believing that selling loans into a securitisation removes all risk for the lender, when the junior layer it usually retains keeps the first losses with it.
- Treating the stated interest rate on the certificates as the return an investor will earn, when early repayments and defaults both change the outcome.
- Assuming a high credit rating refers to the lender, when it refers to a specific layer of certificates and the protection sitting beneath it.
Questions
People also ask.
What backs a CARS certificate?
A pool of car loan receivables held in a trust, together with the vehicles securing those loans and whatever credit support the structure provides.
Why would an investor prefer car loan securitisations to bonds backed by mortgages?
Car loans run for shorter terms and repay more predictably, so the certificates mature sooner and are less sensitive to long-term interest rate moves.
Is early repayment good or bad for the investor?
It returns capital early and safely, but it cuts the total interest earned, so an investor who bought the certificate for its income usually treats heavy prepayment as unwelcome.
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