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Swelling Used Vehicle Supply to Dent Recoveries for US Auto ABS

Falling used vehicle values and swelling supply are set to continue at least through next year, which will lead to worsening recoveries and heightened performance pressures for both auto loan and lease ABS, according to a new Fitch Ratings report.

Losses have been slowly trending higher since 2016, though “The prospect of higher defaults becomes more tangible if increased competition, a decline in sales and looser underwriting standards converge,” said director Margaret Rowe. “Incentives and original equipment manufacturer spending is also up in each of last three years and may further weaken used vehicle values, which will make managing vehicle production levels more critical over the next two years.”

The intensifying wholesale market pressures will not be enough to dent Fitch’s Rating Outlook for auto ABS, which remains positive for this year thanks to growing credit enhancement levels, swift amortisation and Fitch’s through-the-cycle loss proxy approach.

Auto lease securitisations are further protected by including more conservative securitisation mark-to-market Automotive Lease Guide (ALG) residual values (RV). Fitch expects upgrades on subordinate note tranches to continue in 2018, particularly for more seasoned transactions.

Nonetheless, Fitch stress-tested its rated auto ABS with two separate hypothetical scenarios to examine potential rating implications if used vehicles fall more precipitously and supply continues to swell. Under Fitch’s “moderate” scenario (a roughly 20% haircut to recoveries), there would be no rating deterioration for both loan and lease ABS.

Under the “severe” stress scenario (a 50% reduction), however, subprime auto loan ABS could see one- to two-notch downgrades for their subordinate tranches. High investment-grade ratings in both asset classes would see little to no impact and remain stable under this scenario.

“Subprime subordinate tranches show greater potential for multiple compression and downgrades given their reliance on excess spread,” said Rowe. “That said, downgrades would likely be concentrated to the most junior subordinated notes of a subprime deal in the most severe scenario.”

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