By Chris Mrazek, Managing Director, ABS, Fitch Ratings and Kevin D'Albert, Director, ABS, Fitch Ratings
Slowly improving economic fundamentals continue to exert a stabilizing influence on rating actions and collateral performance for non-mortgage related term ABS. While the summer months brought record-high energy prices and weaker than expected job growth, consumer credit quality and collateral performance in the term ABS market remained stable and personal income and consumer-spending levels remained largely on track. Coupled with lower personal bankruptcy filings (for the first time in five years), the economic picture for consumers looks more durable moving forward. Fitch expects continued stable term ABS performance for the remainder of 2004 and into 2005, though there are some potential risks that may impede the path to stabilization, including a sluggish labor market, the effects of rising rates on various credit sectors, high energy prices and on-going concerns about the long-term health of the subprime borrower.
Interest rates and sustainable job creation however, remain concerns. While refinancing activity has slowed for prime borrowers, subprime borrowers continue to take advantage of the relatively low interest rate environment, leaving them with less equity to finance future spending habits. In addition, subprime borrowers are financing largely through the use of adjustable-rate mortgages (ARMs), which may leave them hard pressed to meet obligations as mortgage rates reset and if the rate of home appreciation slows. This also heightens the possibility of reload risk, or the use of unused revolving credit lines to fuel spending patterns at a time when household leverage and debt service burdens are near an all-time high. The combination of variable household liabilities in a rising rate scenario may disrupt stabilizing trends in non-real estate term ABS particularly in the middle and subprime sectors. Ongoing security issues and presidential election jitters may adversely erode consumer confidence though consumer spending and business investment has had and will continue to have a stabilizing affect on collateral performance for the majority of term ABS.
Though industry fundamentals have begun to stabilize, Fitch maintains its negative outlook for the aircraft ABS sector, as both supply and demand factors, along with lease rates, remain weak by historical standards. The sector is also still vulnerable to external shocks. Fitch further remains concerned about the impact of oil prices and labor and pension costs on airline profitability.
With 22 downgraded ratings in the franchise loan sector to date this year, defaults and recovery rates remain under pressure and the risk of future downgrades continues. In particular, Fitch believes competition in the retail gas and convenience store sector, coupled with the instability of certain brands will continue to weigh negatively on Fitch's performance outlook for franchise loan ABS.
Fitch sees negative to stable rating volatility in the small business loan sector due to lower than expected recovery rates and longer than expected recovery timing lags. Other areas of concern include current prepayment experience and concentrations in regional manufacturing, hotel/motel and franchise industries.
On the positive side, Fitch maintains its Stable to positive outlook on the equipment lease sector based on positive collateral performance and improving economic fundamentals. Areas of potential concern include the softening of certain used equipment markets, dampened demand for capital investments and longer recovery lags.
The outlook for timeshare loan is stable given the positive effects of industry consolidation and obligor stability experienced so far this year. Fitch believes expansion by major hotel brands and developers such as Cendant and Starwood continue to lend credibility and seller/servicer strength to this growing asset class.
The prime credit card sector continues to perform within Fitch's expectations and, as such, the outlook for the sector remains Stable. Despite signs of improving performance - particularly in late stage delinquencies, Fitch remains cautious in its near-term outlook for the subprime credit card sector, from both an asset performance and ratings volatility perspective. In particular, Fitch is concerned about higher available credit limits and the potential of reload risk.
Fitch maintains its positive outlook for prime auto ABS both in terms of asset performance and in terms of ratings volatility, while asset performance in subprime autos may remain weak during the next few quarters as that borrowing base continues to recover. Increasing loan terms and Loan-to-Values (LTVs) as well as wholesale market conditions could also adversely affect performance.
Rating volatility decelerated in the third quarter and has returned to historical norms. Year to date, Fitch has issued 136 upgrades and 221 downgrades representing approximately 2.25% and 3.66% of outstanding ratings, respectively. This compares with 32 upgrades and 917 downgrades during the same period in 2003. As stated in previous reports, the elevated number of downgrades experienced last year was the result of 727 ratings actions affecting the entire tobacco bond settlement sector.
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