1/x: To clear up some questions I've gotten about the recently announced $TSLA ABS deal, let's dig through the materials generously provided by Moody's explaining how they came up with the ratings on these notes. Firstly, let's look at the overall structure of the ABS: 
2/x: To quickly explain what this all means, $TSLA is offering a total of $779M in notes backed by this pool of leased Model S/X/3s. Of these, $551M (~70%) are Aaa-rated Class A notes of varying maturities. Also being offered are $54M in Aa2-rated Class B notes,
3/x: $42M in A2-rated Class C notes, $29M in Baa2-rated Class D notes, $31M in Ba2-rated Class E notes. Finally, $TSLA is retaining $70M in face value as overcollateralization. These are junior notes that they keep ownership of to cover losses in the more senior tranches.
4/x: So far so good, now let's look at the characteristics of the asset pool backing the notes. There are a total of 15,706 leases in the pool for an average present value per lease of $49,632. The leases seem to be primarily 3 year leases signed earlier this year.
5/x: Some immediate things to note are: a) the residual value of the cars makes up 56.6% of the total present value of the pool (based on figures from Automotive Lease Guide for residuals). This is not too high for this type of deal, but depends on those values being realistic.
6/x: b) Model diversification is incredibly low. This is extremely unusual for such a deal. Moody's notes it as a risk in their risk/mitigants section, but we will get there soon in the fun part where we discuss what this all means 😉
7/x: First, let's look at how the $TSLA asset pool and structure compares to other issuers. In terms of lease size, duration, and residual value, the deal is pretty normal. What is unusual is the very low diversification in terms of Model, geography, and lease maturity.
8/x: Now the securitization terms. $TSLA issues a significantly smaller tranche of Class A notes compared to other issuers. They also maintain a larger reserve account (at 1.5%) and smaller overcollateralization (at 9%) to cover losses. Let's dig a bit into what this means.
9/x: Credit enhancements in AAA-rated ABS tranches come in 3 flavors: subordination, overcollateralization, and loss reserves. Subordination means that you issue lower-rated notes that take the first loss and protect the AAA-tranche from defaults.
10/x: Overcollateralization means that you retain the lowest rated tranche (in this case 9% of total face value) in order to personally absorb the first losses. Finally, the reserve account is cash that is put down at the start (and maintained) to serve as an additional buffer.
11/x: The three of these sum to give the "hard credit enhancements" listed in the table. For the $TSLA AAA notes, this is 1.5% reserve account, 9% overcollateralization, and 20.25% lower-rated notes for a total 30.75% buffer against losses. Note that this the highest by far.
12/x: Since all of these features reduce investor risk and $TSLA returns, this means that $TSLA is being forced to give better terms to its ABS investors than other manufacturers due to the higher risk of its collateral. Note also that $TSLA stress test losses are the highest.
13/x: But now, lets get to the fun part! What does Moody's make of all this? Are $TSLA credit enhancements enough to make this issue bulletproof AAA-rated paper? First let's look at what they see as the strengths:
14/x: These look fairly straightforward. Yes, the lease FICO scores are generally comparable to other high-end auto ABS and the credit enhancements are above average as we already discussed. Cool, now for the credit risks:
15/x: Okay, COVID is an obvious one. Also, it is good to see Moody's at least acknowledges the credit risk involved with dealing with $TSLA in general. So far so good, but there is more:
16/x: Boom! Poor model, geographical, and lease maturity diversification. These are things we noted earlier, and Moody's is also pointing them out. If 56% of the pool value is residual, you want as much diversification as possible to avoid residual write-downs. But there's more:
17/x: This is the big one! Higher RV as a percentage of total pool is notable, though not outrageous. But limited RV data exacerbated by $TSLA control of the resale channel is the landmine. This basically means the residual values are subject to extreme uncertainty. NOT GOOD!
18/x: Finally, let's look at the analysis Moody's uses to justify the rating. First, they estimate credit losses as 0.5% expected and 4.5% in their worst case stress test scenarios. This is not unreasonable given the FICO scores.
19/x: But the most important part of the analysis is the residual value stress test, which is where things get a bit wild. Right off the bat, Moody's admits that they cannot actually estimate expected RV losses, and will stick to applying a worst-case haircut for the analysis:
20/x: They apply a 55% haircut to residual RV, which is higher than the 35% usual. To justify this, they cite the Model 3 which has only 1 prior similar transaction and makes up 50% of this one (lol), risks related to tech and FSD (lmao), and "potential manufacturer BK" (!!!)
21/x: Also note that they assumed a 100% turn-in rate (meaning all vehicles are returned to $TSLA to be resold through their resale channels) and worst case values of 11k, 20k, and 22k for 3/S/X respectively. (lol at MX MSRP typo). This comes out to 30% loss on the pool.
22/x: Combined with a 4.5% credit loss, the 30% RV loss gives a total 34.5% max stress loss for this $TSLA ABS in Moody's opinion (34.5% is the number from the table in Tweet 8/x). Given that the AAA-tranche has a 30.75% loss cushion, they though it was good enough to sign off.
23/x: In summary, this is not a typical auto ABS deal and I would argue the RV analysis leaves a lot to be desired. To their credit, $TSLA is offering very favorable terms on loss protection (because they have to), but betting heavily on uncertain RV and $TSLA resale channels.
24/x: It is also notable that tech risk and OEM BK are listed as risks for the most valuable and (supposedly) most high-tech OEM in the world. Do I think these notes default? Probably not. But compared to real AAA paper (like MSFT bonds), I know what is the lower credit risk.
25/x: Anyways, hope this clarifies what I meant when I said the rating was to be taken with some skepticism!
@agusnox @DoctorChaosPhD @davidtayar5 @GreatPaul_Smith
@agusnox @DoctorChaosPhD @davidtayar5 @GreatPaul_Smith
