At the outset of 2008, Fitch Ratings analysts enumerated several reasons why the auto industry needed to keep a vigilant watch over unemployment rates. Not much has changed in the unemployment rate, yet Fitch analysts now seem to have a much rosier, it still cautious, outlook on the auto ABS sector.
In a report titled "U.S. Auto Finance: Road Work Ahead" from last February, analysts highlighted the important role that unemployment plays in the health of the auto industry. It seemed that the rating agency delivered a sobering rundown of prospects for the U.S. auto finance industry.
Despite the fact that autos are one of the staple U.S. consumer ABS assets, issuance has been down in late 2007 and so far in 2008. Further, because of problems in the bond insurance market, most of the issued deals had a senior/subordinate structure. If this continues, auto lenders will have to retain an appropriate amount of capital and liquidity on the balance sheet to account for the relative risk of the asset, wrote Fitch.
The rating agency's Auto ABS Annualized Net Loss Index showed that prime and subprime losses bottomed out at 0.52% in June 2006 and 3.27% in May 2006. The unemployment rate increased to hit 5% in December 2007, while the prime and subprime indexes deteriorated to 1.34% and 7.56%, respectively.
"Signs of continued weakness in the economy will pressure consumers further and Fitch believes prime and subprime auto losses could increase above 2% and 11%, respectively, in 2008, said Fitch.
Fitch updated its point of view last week, after investor inquiries prompted it to analyze the historical relationship between changes in the unemployment rate and changes in certain consumer ABS loss rates. It looked at potential loss rates for both auto and credit card ABS deals. Increases in the unemployment rate are expected to cause auto loan and credit card loss rates to increase proportionally, with subprime assets seeing the highest proportional rate, said Fitch.
Unemployment, in isolation, would have to increase from 4.8% to more than 20% in order to cause a first-dollar loss to typical triple-A credit card and auto transactions. Typical triple-B securities could withstand an increase in the unemployment rate to more than 9% for auto transactions, said the rating agency.
And what is the likelihood that unemployment rates in the U.S. will reach those levels? Post war unemployment peaked at around 10.8% in 1982, and over the past 30 years, the unemployment rate has averaged around 6%.
"Consumer ABS transactions rated triple-A can withstand unemployment stresses not seen since the Great Depression," said Kevin Duignan, a managing director at group head at Fitch.
The rating agency says it is working on a more detailed report to discuss its findings. Recent government statistics suggest, however, that the auto finance and securitization sectors can take a breather on addressing those issues. Last Thursday, the Labor Department reported that new unemployment claims were 366,000, about 9,000 fewer than the revised 375,000 from the previous week. And by the date of the report, the unemployment rate was at 4.8%.
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