There is evidence of correlation in the state of the wholesale vehicle market and annualized net loss (ANL) rates in auto loan asset-backed securities (ABS). Fitch Ratings recently assessed between how wholesale vehicle values affect recoveries of defaulted auto loans, and concluded that the values in turn impact loss severity and, ultimately, loss rates in auto ABS, thus creating an inverse relationship between wholesale vehicle values and ANL rates in auto ABS - as wholesale vehicle values rise, ANL rates invariably fall and vice versa.
Therefore, the healthier the wholesale vehicle market, the lower loss severity in auto ABS as vehicle recovery rates increase and, hence, loss levels ultimately decrease. Fitch's analysis confirms that loss severity is an important driver of ABS loss rates and, combined with the current higher default rates, it will continue to put pressure on auto ABS performance.
The primary sources of data utilized in this analysis were the Manheim Used Vehicle Value Index (Manheim Index), which reflects the state of the wholesale vehicle market, and Fitch's ANL indexes for both the prime and subprime auto ABS sectors.
Factors affecting the wholesale vehicle market include: the state of the economy; used vehicle supply and demand factors; dealer activity and profitability; factory output (production); inventory levels; the state of the new vehicle market; vehicle pricing and affordability, including the availability of financing and incentive levels; and the type, certification, and condition of a used vehicle
Fitch observed the following from its statistical analysis of the relationship between the wholesale vehicle market and ANL rates:
* There is a high degree of correlation between the wholesale vehicle market and the prime and subprime ANL indexes.
* Fitch observed that at a 95% confidence level a one-point increase in the Manheim Index would result in a 6.3 +/-1.3 basis point decrease in the prime ANL index and 29.4 +/-8.2 basis point decline in the subprime ANL index.
* The prime auto ABS ANL index has a higher correlation to the Manheim Index than the subprime auto ABS ANL index, with correlations of 79.2% and 68.0%, respectively.
Analysis
Despite many variables affecting the loss rates in securitizations (e.g. loan term, loan-to-value ratios, timing of defaults, servicer proficiency, and type/condition of vehicle), a simple regression analysis proved a relatively high predictability of the ANL index movement relative to the changes observed in Manheim Index (adjusted R-Square of 62.0% for prime auto ABS ANL index and 45.3% for subprime auto ABS ANL index).
Despite the presence of many other factors that may adversely affect loss severity and loss rates in auto ABS, the expected health of the wholesale vehicle market is a good indicator of future loss severity levels and loss rates in auto ABS. Currently, the wholesale vehicle market is exhibiting weakness due to several factors, including a weak economy and soft job market.
Additionally, loss severity in auto ABS is under pressure due to lower used vehicle values and loan structure trends, e.g. longer loan terms and higher loan-to-value ratios. Nevertheless, rating performance has been stable in the prime auto ABS sector through the first quarter of 2008, even in light of declining asset performance. In the subprime sector, outside of ratings actions related to the financial guarantors' insurer financial strength, rating performance has been relatively stable in 2008 despite negative asset performance within the sector.
To mitigate the risks stemming from the wholesale vehicle market, Fitch will continue to monitor the health of the wholesale vehicle market (used vehicle market) and utilize this market data during its qualitative and quantitative analysis of auto ABS transactions when determining base case loss proxies and stresses in auto loan-backed securitizations.
Fitch's auto ABS ANL indexes is comprised of auto ABS transactions rated by Fitch. The combined indexes total approximately $64 billion worth of auto ABS, of which the prime index totals approximately $42 billion and the subprime index about $22 billion.
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