U.S. auto loan ABS collateral performance has turned the corner over the past two years, despite ongoing economic stress and persistent pressure on U.S. consumers overall. Losses among 2009 deals have reverted to pre-recession levels, with losses in the 2010 vintage likely to follow suit.
Stricter underwriting, improved pool characteristics, a gradually stabilizing economy, and an improved wholesale used-vehicle market have all contributed to the notable improvements in expected loss performance for auto loan ABS rated by Fitch Ratings. As of October 2010 reporting, Fitch's forecast cumulative net losses on the 2009 vintage were 1.3%-1.5%, notably lower than the 2.8%-3% range Fitch projects for the 2008 and 2007 vintages. Fitch expects cumulative net losses for 2009 will be more likely to reach levels consistent with recent, pre-recessionary vintages, namely 2005-2006.
The wholesale vehicle-market will remain stable in the near future and relative economic stability will continue to support the low loss levels observed on the 2009 vintage. This will lead to similar performance on the 2010 vintage of prime auto ABS. As such, Fitch's rating outlook for the prime auto ABS sector is positive moving into 2011, with rating upgrades expected to continue substantially outpacing downgrades. Fitch has isolated certain key variables that have attributed to the improvement in the 2009 vintage performance, as detailed below.
High Unemployment Rate
Intuitively, as consumers lose jobs, they may no longer be able to make payments on their auto loans. Therefore, Fitch would expect to see increasing levels of unemployment translate into a higher frequency of loan defaults. To demonstrate the effect of more borrowers losing their source of income, Fitch examined the correlation between U.S. new jobless claims and monthly net losses.
The 2007 vintage was chosen by Fitch because it encompasses the most complete timeline the beginning and end of the 'Great Recession'. As a result. this vintage best shows the impact macroeconomic factors had on the auto ABS industry. monthly net losses display a stronger relationship with new jobless claims than overall unemployment, as new job losses rather than long-standing unemployment are more likely to produce incremental defaults.
For example, beginning in month one, all indices show increasing trends of losses. But at months 18-20, which would approximately coincide with the end of the recession in mid-2009 (June 2009 according to the National Bureau of Economic Research), both monthly net losses and new jobless claims started to fall, while unemployment remained elevated.
It is important to recognize that other drivers exist that could adversely affect monthly net loss performance. For example, the 2008 period saw poor supply/demand economics from the major auto manufacturers, loose underwriting standards, and included periods of highly volatile gas prices, all of which could negatively influence loan performance.
Poor Recovery Performance
Stemming from weakness in the wholesale vehicle market, poor recovery performance is viewed as a significant macroeconomic driver of losses in prime auto ABS. Table 1 on the next page, also based on the 2007 vintage, exhibits the inverse relationship, or negative correlation, that exists between monthly net losses and wholesale used-vehicle values. As the Manheim index decreases (indicating higher loss severity or lower recoveries), monthly net losses tend to increase (refer to Table 2 in the next page).
Other drivers of loss severity could also influence monthly net loss performance. For example, higher initial LTV ratios create the potential for negative equity, which would translate to higher losses upon vehicle liquidation.
Although the discussion of these factors focuses on the 2007 vintage, similar relationships can be observed in the 2005 and 2008 vintages. However, the 2009 vintage has shown some divergence, as tighter underwriting standards, improved employment conditions, and an improved wholesale vehicle market began taking effect.
Underwriting Changes
The improvement in the performance of the 2009 vintage of auto loan ABS not only reflects some stabilization of macroeconomic factors, but also a deliberate and significant improvement in the quality of securitized collateral.
During 2006 and 2007, many auto loan originators loosened underwriting guidelines and opted to expand their risk thresholds to accommodate higher advance rates (LTVs), lower credit scores, higher payment-to-income ratios, and longer loan terms. Beginning in mid-2008, most prime auto loan originators began to reverse many of these changes to originate higher credit loans with more conservative loan terms. Most notably, originators focused on higher borrower credit (FICO) scores and/or better originator-derived credit scores, limiting advance rates LTVs, and more conservatively setting other underwriting parameters, such as payment/debt-to-income ratios. Additionally, most originators made it more difficult for lower FICO borrowers to qualify for higher risk loans, such as those with high LTVs or long original terms (refer to Table 3 above).
Another factor to consider is the timing of loan originations included in the 2009 auto ABS vintage. Most loans pooled in 2009 transactions were originated in late 2008 and 2009. Prime borrowers purchasing vehicles in that period of rising unemployment and economic uncertainty were likely employed and less likely to be concerned with a potential drop in or loss of income. In effect, those still pursuing vehicle financing in the economic downturn were positively selected relative to the general population.
To date, the characteristics of the 2010 vintage of auto loan ABS largely mirror those of the 2009 vintage, and early performance has followed suit. Economic stability remains tenuous, and all consumer ABS sectors, including autos, remain susceptible to performance deterioration resulting from economic weakness, particularly on the labor front. However, if current conditions hold or improve slightly through 2010 as Fitch expects, borrower defaults will remain at stable levels. Based on current vehicle production, scrap levels, used-vehicle supply, and expected demand in the near future, Fitch expects that the wholesale vehicle market will remain relatively stable as well. This should continue to support loan recovery rates in line with historical experience and above the 2008 and early 2009 levels. Assuming these factors hold, Fitch expects that the 2009 and 2010 vintages of auto loan ABS will continue to significantly outperform those of 2007 and 2008 and that rating upgrades will continue to greatly outpace any minimal potential downgrade activity. Fitch will continue to monitor all outstanding auto securitizations in an effort to provide timely opinions to the market.
Fitch expects underwriting standards to begin loosening in 2011. Changes will likely open up vehicle financing to lower credit scores than those that qualified in recent years. While the extent of this expected reversal remains to be seen, Fitch does not expect portfolio quality to deteriorate to 2007-2008 levels in the near term. However, Fitch remains focused on capturing any additional risks.
John Bella is head of Fitch's U.S. auto and commercial ABS group and Brad Sohl is part the U.S. ABS group.
