The U.S. economy shrugged off significant obstacles in 2005, dodging with seeming agility ongoing geopolitical uncertainty, hurricanes, rising interest rates and mounting fuel costs. In addition, the economy proved resistant to fears of falling home prices and persistent weakness in the airline and automotive industries. Even concerns regarding the potential negative impact of bankruptcy reform proved illusive. Through it all, collateral continued to demonstrate resilience throughout the majority of non-mortgage-related consumer and commercial non-mortgage-related term ABS.
Recent turbulence in financial markets has highlighted concerns about rising inflation and slower job creation. Fitch is concerned about the convergence of these overlapping macroeconomic factors on asset performance and the potential impact on outstanding ratings across the full spectrum of structured finance markets and regions. In spite of these forces, Fitch Ratings anticipates prime consumers to continue strong performance throughout the year and maintains a stable outlook on the prime auto, credit card and student loan segments. However, despite performance improvements on a year-over-year basis, Fitch maintains its negative to stable outlook from both an asset performance and a rating volatility perspective for the sub-prime consumer sectors. In addition to volatility in monthly delinquencies and losses, Fitch remains wary about ongoing intense competition within the consumer finance sector and its impact on underwriting standards, especially for sub-prime borrowers.
On the commercial side, the equipment lease sector is expected to display continued strength, while Fitch's outlook for the franchise and small business loan sectors remains clouded by smaller net recoveries and longer-than-anticipated recovery times on certain transactions. Likewise, the aircraft sector is expected to remain weighed down by higher energy prices and persistent industry weaknesses. Similarly, dealer floorplan and rental fleet ABS are expected to come under pressure due to higher loss severities and lower payment rates resulting from exposure to auto manufacturers.
The combined effects of strong collateral performance and improved seller seller/servicer strength enhanced deal structures and led to positive rating actions. In the first six months through June 22, 2006, ABS upgrades have out paced downgrades by a ratio of nearly 2:1. Consistent with historical trends, most of the upgrades were concentrated in the consumer sectors; however, there were also a number of positive rating actions in the commercial equipment sectors.
Key rating activity highlights include:
* For the six months ended June 15, 2006, Fitch issued 69 downgrades, compared with 149 during the same period last year. Negative rating actions for the most part were limited to ratings that had been previously lowered in the commercial sector with downgrades taking place in franchise loans (35) and aircraft (32). In the consumer sector, so far this year there have been only two downgrades in recreation vehicle loans. Franchise loan downgrades were related to lower than expected recoveries on exiting defaulted loans, resulting in reductions credit enhancement available to support outstanding bonds.
* Year to date, Fitch issued 92 upgrades, compared with 33 in the first six months of 2005. Upgrades were more heavily concentrated in the consumer sectors including, auto loan (32), credit card (45) and recreation vehicle loans (4). On the commercial side, aircraft (2) and equipment leasing/loans (9) also participated in the positive rating action. Credit card upgrades reflected improving seller/servicer performance due to industry consolidation. All positive actions were related to better than expected collateral performance which allowed the structures to provide adequate loss protection relative to the assigned rating categories.
Additional highlights also included in Fitch's soon to be released Mid-Year Review and Outlook includes:
* Market innovation and new assets: Over the past six months, Fitch has reviewed proposals for the issuance of bonds backed a wide variety of intellectual property types such as pharmaceutical royalties, commercial patents (trademark, media and entertainment) and other intangible assets. Fitch has also looked at a wide variety of insurance-related assets, including catastrophe bonds, life settlements and the funding of statutory "XXX" reserves. Issuance in each of these sectors has taken off as a result of as insurance companies have to capital constraints placed on life insurance companies in the wake of the natural disaster activity in 2005.
* Reg AB compliance remains a hot button: Regulation AB which went into effect January 1, 2006, refers to guidelines set forth by the Securities and Exchange Commission governing the registration of publicly-offered asset-backed securities. In addition to the registration of securities, guidelines also cover disclosure requirements, static pool data requirements, communications during the offering process, and ongoing reporting requirements. One of the more onerous requirements is that Reg AB requires that five years of static pool data be provided for comparable pools prior to a deal being issued. Another critical component of Reg AB is a new broader definition the role servicer. Although these rules are clearly beneficial to both investors and sponsors of securitization vehicles, Fitch believes ongoing dialogue should focus and simplicity. Further clarification is needed regarding the ultimate role and responsibility of the servicer, including information and qualifications, servicing agreements, and backup serving the guidelines.
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