Dealer floorplan ABS losses currently remain low, with performance metrics within range of historical levels. U.S. dealer networks have been exhibiting some stability and improvement in certain areas since the middle of last year. With the U.S. economy and auto industry stabilizing, automobile sales have picked up, all contributing to higher dealer profits as dealership costs declined, a notable change from the tremendous stress that dealerships were feeling in 2008 and the first half of 2009.
Following several years of mounting pressures, the financial condition of U.S. auto dealers is recovering, albeit slowly, as the majority of dealers recorded a profitable 2009. This bodes well for the overall performance of U.S. dealer floorplan ABS in 2010. U.S. auto dealer networks appeared to have reversed course financially starting in the second half of 2009, coinciding with the U.S. economy stabilizing and showing signs of improvement.
As such, Fitch Ratings' outlook for both auto and diversified dealer floorplan ABS in 2010 continues to be stable. Asset performance is expected to remain within historical averages. Furthermore, transactions benefit from structural features and protection, including credit enhancement, dealer concentration limits, and early amortization triggers.
Despite the improving health of U.S. auto dealerships, dealer floorplan ABS asset performance will continue to be constrained by several factors, including:
-The current state of the U.S. economy and slow recovery;
-Low vehicle sales relative to prior years;
-The difficulty accessing credit by dealers;
-Low profitability; and
-Continued weakness in several diversified equipment sectors.
Some of the key metrics that Fitch analyzes in its assessment of dealer floorplan ABS performance include monthly payment rates (MPRs) and purchase rates (which measure the level of sales, inventory turnover, and dealers' ability to repay credit lines); inventory aging (which reflects the pace of sales and potential collateral value deterioration); dealer credit risk ratings; and loss rates resulting from dealer defaults.
Portfolio Performance Metrics
Purchase rates demonstrate the pace at which a trust is replenishing its receivable pool. In a flat product sales environment, purchase rates should loosely correlate to MPR. Historical rates have shown that it is common for auto dealer floorplan transactions to have purchase rates of more than 50%. Conversely, more diverse portfolios have lower purchase rates due to the nature of the products and sales patterns, and are consistent with the lower MPR experience seen within these trusts. A high purchase rate indicates that dealers need more inventory on their floors, which may result from increased vehicle sales or dealer expansion. A low purchase rate may mean that inventory is depreciating on dealer lots for extensive periods due to dealers having difficulty selling vehicles/equipment/products.
A recent Fitch review showed a second half-2009 resurgence in purchase rates for dealer floorplan transactions as sales rose amid the stabilizing U.S. economy. Diversified dealer floorplan transactions commonly have lower purchase rates, which is natural for assets collateralizing dealer credit lines.
Monthly Payment Rate:
MPRs are generally a strong indicator of dealer floorplan ABS health, as they represent a product sale or other dealer payment. MPRs also provide a gauge of underwriting management since credit lines are generally sized to an anticipated sales rate and, therefore, while seasonal, should be somewhat stable. Volatility can arise due to seasonality, slower actual sales, and/or dealer and customer incentives that may cause inventory changes.
To measure industry trends, Fitch's dealer floorplan ABS MPR index tracks the performance of securitized receivables. As of the end of May, the aggregate index included approximately $11.0 billion of receivables. An examination of the MPR index shows that both the diversified and auto sectors exhibited negative trends from November 2007 through June 2009, before showing improvement in later 2009 and 2010. MPR declines in the diversified portfolio were within historical ranges, despite the slowdown in the U.S. economy, given that this sector combines many different industries and product lines, which ensures industry, product, manufacturer, and dealer diversity. Fitch's diversified dealer floorplan ABS MPR index reveals greater stability but lower absolute rates, which is often a function of longer sales timelines given the nature of the products.
The MPR index for the auto sector shows notable declines to the lowest levels ever from December 2008-June 2009 as the aggregate MPR fell below 30% for the first time since the inception of the index in 1999. The index ranged from 25.4%-27.4% during this time as the U.S. auto industry struggled to right-size inventory on dealer lots.
Fitch's auto-related MPR Index exhibited notable improvements during the second half of 2009 as auto manufacturers slashed production and looked to reduce inventory levels to match lower demand and overall sales. By September 2009, the aggregate MPR for non-auto dealer floorplan platforms exceeded the 30% level, while that of the auto index topped the 40% level for the first time since November 2007. Despite the MPR slowdown in both sectors, all Fitch-rated dealer floorplan ABS remained above early amortization trigger levels.
Inventory aging statistics are key indicators of slowing sales and collateral value deterioration. As inventory ages, its value may begin depreciating, which may affect the dealer's ability to make full repayment or place more dealer reliance on the manufacturer/finance company for discounts. Partial payments (or curtailments) are often required to offset asset depreciation; however, if a dealer defaults, a loss may arise upon sale of older inventory.
As demand declined for most durable goods, most dealer floorplan platforms saw an increase in product aging in 2008 and 2009. For instance, U.S. automobile inventory agings exceeding 180 days increased in 2009 in most dealer floorplan ABS transactions and peaked in mid-2009. Inventory aging statistics returned to historical levels at year-end 2009 and 2010.
Fitch-rated dealer floorplan ABS transactions have incurred minimal losses to date. In cases of dealer defaults, closures, and bankruptcies, lenders were able to recover the majority of defaulted collateral value, ensuring full repayment of their outstanding credit lines.
Diversified-equipment dealer floorplan ABS transactions have also experienced low loss levels. Dealer, manufacturer, industry, and product diversification, along with their applicable concentration limits, help constrain losses in these sectors. Furthermore, there is high manufacturer support in case of diversified- and single-manufacturer dealer floorplan platforms. Consistent with the auto sector, this support comes in many forms, including marketing and advertising, dealer bonuses and incentives, inventory financing, and unsecured or asset-based lending. On the customer side, vehicle warranties, discounts/incentives, and availability of competitive retail financing all support sales.
Sold out of trust (SOT) occurrences, a main driver of losses, remain historically low. SOT occurs when a dealer sells the underlying asset but does not remit the sales proceeds to the lender for repayment of its line, a practice that constitutes fraud and is closely monitored as a performance metric of dealer floorplan ABS. Fitch has not observed significant increases in SOT cases in its rated dealer floorplan ABS transactions during the past two years.
Excess spread, the difference between interest earned on receivables and interest payable on bonds (further reduced by servicing fees and trust expenses), has remained relatively stable on a historical basis because both asset and bond yields are based on floating rates. Excess spread in auto dealer floorplan platforms tends to be lower than in diversified dealer floorplan ABS, due to the lower asset yield, ranging from 2%-6% historically.
John Bella, Jr. is a managing director and head of Fitch's U.S. auto/commercial ABS group. Hylton Heard is a senior director in the same group.