Despite concerns over rising interest rates and the pervasive threat of another terrorist attack, analysts at Fitch Ratings outlined a broadly favorable view of ABS performance in 2Q04, and are forecasting continued growth in several sectors for the remainder of the year.
"The second quarter built on economic gains from previous quarters and exerted a stabilizing effect on ABS performance," said managing director Chris Mrazek during a recent conference call. "Job growth hit its stride, while consumer spending and lower bankruptcies signal a more durable economic recovery."
Mrazek noted that the quarter-point hike in late June had no negative impact on consumer spending.
Meanwhile, the downgrade rate for ABS dropped to 1.1% for the quarter, compared with 1.7% in 1Q04. Moreover, a majority of ratings downgrades were limited to previously lowered tranches, and performance-related downgrades were confined to non-investment grade bonds, suggesting that the severity of deterioration has slowed. The ABS market suffered no defaults in 2Q04, Mrazek added, further indication of strong quarters to come.
Group Head and Managing Director Mike Dean said that fiscal and monetary stimulus has continued to benefit consumers from a cashflow perspective, while the asset side of their balance sheets is appreciating from solid gains in home prices and personal growth. However, Fitch does expect rising rates to offset these gains somewhat. The threat of rising rates is exacerbated by the prevalence of adjustable-rate mortgages, particularly in the sub-prime sector, where adjustable-rate mortgages comprise 60% of the market. The effect could be contagious for consumer ABS.
"The new reality is that as rates rise, consumers will have less cashflow available to service existing non-mortgage related obligations, such as autos, credit cards and student loans, and for new purchases," Dean said.
Sector by sector, the ABS market had little in the way of surprises for the quarter. Credit card performance was improved across the prime, subprime and retail sectors, but experienced predictable seasonal volatility, said Fitch Director Richard Drason. There were no downgrades in the broad credit card universe. Issuance was at $26 billion through June 30, 33% below 2Q03 levels, Drason said.
The outlook on the prime credit card sector remains stable, with excess spreads posting highs for the quarter not seen since December 2003.
Subprime and retail portfolios have not fared quite as well, and Fitch maintains a negative outlook on both sectors. Excess spreads in the subprime arena dipped slightly during the quarter, Drason said, and could create future volatility or instability.
"If not offset by falling chargeoffs or an uptick in [portfolio] yield, excess spread levels could feel some pressure in the months to come as funding costs trend upwards," Drason said.
Performance in both prime and subprime autos was on the upswing for the quarter, said Director Warren Wells. Strong issuance in June led volume to finish ahead at $44.1 billion, representing a four percent increase over year-ago levels.
The outlook on the prime sector is stable, and Wells anticipates the posisitive ratings momentum to persist. "The concern is that longer-term loans, increasing LTVs and other competitive strategies and could lead to changes in underwriting and performance," Wells said.
Although subprime auto shows signs of stabilizing, Fitch's outlook stayed put at negative. The sector is particularly vulnerable to weakened consumer spending, rising rates and a soft wholesale vehicle market, Wells said.
The outlook on student loans is steadily positive, said Director David Hartung. Furthermore, the tightening seen in Sallie Mae spreads during recent weeks highlights the growing acceptance of the asset class, which could well translate into opportunity for smaller-name issuers as investors seek to diversify in the ABS universe, Hartung said.
The aircraft lease sector continued to limp toward recovery during 2Q04. The rating agency maintains its negative outlook, said Don Powell, senior director. "Fundamentals have bounced off of post- 9/11 lows, but oil prices, terrorism and financial problems at the airlines have hammered growth," Powell said.
Fitch anticipates corporate jet and repackaged lease transactions will drive issuance during the second half of the year.
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