Most 'AAAsf'-rated U.S. prime auto ABS outstanding classes of notes were able to withstand a hypothetical recession and material drops in used-vehicle recovery rates, according to recent stress tests done by Fitch Ratings.
The stress tests were part of a bigger study into how robust global structured finance ratings are in a prolonged economic downturn. The firm expects to conduct similar stress tests in the upcoming months for other asset classes.
Fitch subjected its ratings on prime auto loan ABS to two stress scenarios, which are moderate and severe.
The moderate scenario would be similar to conditions seen in the country in the recessionary 2008-2009 period. The firm calibrated the severe stress scenario to be considerably more stressful as it assumes unemployment well above peak U.S. levels and limits wholesale vehicle values well below the historical lows recorded in this time period.
The rating agency stressed the two factors that most directly impact asset performance. These are U.S. unemployment, which drives loss frequency, as well as recovery rates on used-vehicle values of defaulted and repossessed loans, which impacts loss severity.
To examine the impact on outstanding 'AAAsf' ratings, Fitch stressed unemployment from a base level of 6% to 12% under the moderate scenario and 20% for the severe case. Fitch reduced assumed wholesale vehicle values from 50% down to 40% historical average under the moderate case and 25% for the severe case.
With the moderate scenario, the rating agency expects all 'AAAsf' rated notes to remain in the investment grade category with close to three quarters of these ratings expected to stay at 'AAAsf', while about 90% would remain at the top-two rating categories, Fitch said.
Fitch thinks the likelihood of the severe scenario happening where unemployment increases to 20% and recovery rates drop to 25% is very unlikely. But, if this were to occur, the agency's analysis found that the scenario would likely cause 67% of outstanding 'AAAsf' rated notes to be downgraded to non-investment grade and the remaining 33% should remain rated investment grade.
Seasoned deals or those in the 2006-2008 vintages, which have some of the highest loss rates to date, can withstand even the severe stress since they are mostly paid off and have built considerable enhancement, the agency reported.
Meanwhile, the 2009-2012 deals, which have some of the lowest loss rates to date, are more vulnerable to downgrades in the severe scenario, but will largely be able to withstand even this stress. In a moderate scenario, most 'AAAsf' ratings issued in this period would stay in the 'AAAsf' rating category and no ratings should drop below investment grade.
The moderate scenario was designed to be consistent with that observed in 2008-2009. The severe scenario assumed a dramatic downturn in the U.S. economy with unemployment rising to 20% together with an immediate drop in vehicle values to never-before-seen levels.
The rating migration under both scenarios is much more severe versus the actual rating migration seen in 2008-2009. During this time period, the rating agency only issued three downgrades on investment-grade rated prime auto ABS notes and they were to only one category. Almost every Fitch-rated subordinate note saw positive ratings actions such as those from the 2006-2009 vintage deals.
