Significant liquidity constraints and deteriorating credit fundamentals in the subprime mortgage market have yet to make a meaningful dent in the rating performance of U.S. consumer ABS, according to Fitch Ratings. Over time, Fitch anticipates that there will be a modest deterioration in the performance of credit card, auto and student loan collateral due to increasing economic pressures. This deterioration, however, begins from a period of historically low loss rates and is expected to generally remain within Fitch’s base cases.
While fears of subprime contagion persist, Fitch has observed little impact on the performance of credit card, auto and student loan backed ABS. Changes in consumer spending, employment growth, and increased household debt leverage, however, are signaling that asset performance may be more volatile going forward. Despite these signals, Fitch anticipates limited increased rating volatility in US consumer ABS given the current levels of credit enhancement and structural protections inherent in these deals.
Fitch expects a slowdown in consumer spending as falling home prices, higher borrowing costs and volatile energy prices cause households to refrain from making big-ticket purchases. On the employment front, although new job creation has remained respectable for much of the year, weakness in the housing-related and mortgage finance sectors will erode current employment levels. These added strains faced by consumers will lead to an increase in household debt levels and personal bankruptcy filings which could impact consumer ABS performance over the longer term.
Credit Card ABS:
Despite a rise in delinquencies and chargeoff rates in both prime and subprime segments year-over year, credit card ABS portfolio performance has remained generally stable. Positive performance trends are expected to continue into next year, although Fitch is cautious about subprime borrowers who remain financially stretched.
Rising personal bankruptcies are one of the primary reasons for higher delinquencies and losses on credit cards. However, much of the rise in personal bankruptcies can be attributed to a return to historically observed levels seen prior to the spike and subsequent drop in filings which occurred around the implementation of the Bankruptcy Reform Act in October 2005. At the same time, the rise also reflects the economic reality of households under increasing financial stress.
Recent increases in household debt and in the use of revolving credit reflect an increasing reliance on credit cards as higher borrowing costs and declining home prices have made home equity extraction more difficult. These conditions, along with along with higher interest rates may result in higher delinquencies and losses moving forward. Even with the increased sensitivity of subprime credit card borrowers, excess spread levels for most Fitch-rated transactions are robust and sufficient to absorb higher losses.
Auto ABS has also seen higher delinquencies in both prime and subprime segments on a year-over-year basis, though the increase is off of historic lows from last year. As a result, Fitch’s Outlook for the prime auto ABS remains Stable for the remainder of this year and into early-2008. Though Fitch remains more guarded in its outlook for subprime auto ABS due to pressures facing the consumer and historical volatility in monthly delinquencies and losses, rating changes will be limited since most transactions in this asset class are wrapped by an ‘AAA’ financial guarantor.
Recent weakness is due in part to seasonal factors. With new models expected to be rolled-out in the fall, manufacturers and dealers are focused on clearing out existing inventory through the use of higher incentives and discounts. Looking forward, Fitch is concerned about competitive pressures and declining sales faced by the U.S. auto manufacturers more so than subprime contagion risks. Declining sales and market share by U.S. auto manufacturers will likely intensify competition which could negatively impact vehicle prices and residual value realization for certain vehicle segments, most notably SUVs/trucks.
Student Loan ABS:
Rating performance for both FFELP and private student loan ABS should remain stable for the remainder of 2007, though economic pressures on the US consumer are likely to push loss rates moderately higher. There also remains considerable uncertainty surrounding proposed higher education legislation amendments. While the proposed changes are unlikely to affect underlying credit fundamentals on existing student loan ABS, the changes may lead Fitch to raise its initial credit enhancement levels for new FFELP transactions due to lower excess spread from reduced Special Allowance Payments (SAP) and lower reimbursement guarantee fees.