A new Fitch Ratings report shared results of internally conducted stress tests that likely won’t please recovery managers, but these findings nevertheless cannot be ignored by any finance company, regardless of size.

Fitch explained that falling used-vehicle values and swelling supply are set to continue at least through next year, which will lead to worsening recoveries and heightened performance pressures for both auto loan and lease ABS.

Losses have been slowly trending higher since 2016, though, “The prospect of higher defaults becomes more tangible if increased competition, a decline in sales and looser underwriting standards converge,” Fitch director Margaret Rowe said.

“Incentives and original equipment manufacturer spending is also up in each of last three years and may further weaken used vehicle values, which will make managing vehicle production levels more critical over the next two years,” Rowe continued.

The intensifying wholesale market pressures will not be enough to dent Fitch’s rating outlook for auto ABS, which remains positive for this year thanks to growing credit enhancement levels, swift amortization and Fitch's through-the-cycle loss proxy approach.

Auto lease securitizations are further protected by including more conservative securitization mark-to-market Automotive Lease Guide (ALG) residual values. Fitch expects upgrades on subordinate note tranches to continue in 2018, particularly for more seasoned transactions.

Nonetheless, Fitch stress-tested its rated auto ABS with two separate hypothetical scenarios to examine potential rating implications if used vehicles fall more precipitously and supply continues to swell.

Under Fitch’s “moderate” scenario (a roughly 20 percent trimming to recoveries), analysts determined there would be no rating deterioration for both loan and lease ABS.

Under the “severe” stress scenario (a 50-percent reduction), however, analysts indicated subprime auto loan ABS could see one- to two-notch downgrades for their subordinate tranches. Analysts added high investment-grade ratings in both asset classes would see little to no impact and remain stable under this scenario.

 “Subprime subordinate tranches show greater potential for multiple compression and downgrades given their reliance on excess spread,” Rowe said. “That said, downgrades would likely be concentrated to the most junior subordinated notes of a subprime deal in the most severe scenario.”

The report titled, "Supply & Severity: Will Swelling Used Vehicle Supply Impact Auto ABS Ratings?" is available at www.fitchratings.com.