Hi Dan
Pls see my other post today just now, and I agree with the comments by SteveSage and Tekvest.
Professional investors supply about 95% of the funds to buy notes in the trust. The notes have strict security ranking, so the safest ones are the cheapest at 1.35% + the bank bill rate. The riskiest slices of these deals often go for about 10% over the bill rate, because they take the first losses. These trusts usually have only a tiny amount of true “equity” say $100 but MME must buy the lowest rating/most risky slice. This is usually about 5% to 7% of the trust’s deal size. Here the trust will be funded by about $10m cash supplied by MME with the rest, say $168m, provided by investment institutions . Out of that $178m pool of cash, about $9-15m will be kept in cash as a buffer for losses (to ensure that the repayment obligations to the Noteholders are met without any interruption; the rest of the cash is used to buy the car loans etc from MME).
If someone wants to buy a car, in the first place MME lends them the money from its own balance sheet. When it has made about $5 to 10m such loans it packages them up and transfers them to the funding trust in exchange for cash.
“frees up capital fornew loan originations” means that MME had probably used up most of its ability to fund loans (of this type) with other trusts and so had been accumulating assets on its own balance sheet. This is expensive as it would be using its own equity to fund those assets. It’s much cheaper for MME to transfer those assets into a trust ASAP and get about 95% of the money back from those financiers at say bill rate +2.5% overall, rather than 100% from its own capital..
As I said in my other post today, the average cost of this trust will be about 2.5% over bank bills. That is still cheaper than it would cost MME to borrow from a bank with standard loan facility. Much more important though is the greater flexibility and higher level of gearing it can use with these trusts: a standard bank loan might allow them to borrow at best 60 or 70% of the value of the loans, whereas these trusts allow much higher gearing- about 95% in today’s market- and fewer conditions. That is the main benefit for MME and peers. If MME used a normal bank facility it would have to back its loan products with much more of its own equity, which would make the average cost of issuing say a car loan prohibitively expensive, crippling the business, and the customer would probably be able to get a cheaper deal from a bank.
The only security that these lenders have is to the portfolio of loans themselves and the cash in the trust, not to other assets on MME’s balance sheet. If the car loans (when in the trust) go bad- ie not making their interest and principal repayments on time- that is a problem for the trust. The first bad debt loss is taken against the lowest ranking money- which MME itself invested If further losses occur they hit investors gradually higher up the security ladder. The cheap pricing on the top tier- which is why it has a AAA credit rating- is because it is extremely unlikely that the car loan portfolio will get so bad that the top tier investors will lose anything. The top tier can safely be as much as 75% of the trust funding, because they would only take a hit once over 25% of the loan assets have gone bad. MME’s usual bad debt levels are only about 4 or 5%- even a 10% loss rate would be exceptionally severe
Because of the very high gearing the investors (or in practice the ratings agencies) have to do a lot of due diligence and obtain very detailed histories of loss rates from cos like MME, so they are confident with the expected risk/ return trade off even in difficult economic conditions, often over a term of 4 or 5 years.
