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Unemployment Rates vs. Defaults

July 2009, F&I and Showroom - WebXclusive

by Nick Levenstein

I read with great interest Aaron Dalton’s “Singing the Big Apple Blues” (Dec. 2008, page 18), which discussed apprehensions common to the fund managers who ensure the flow of capital into the auto finance market. Like Mr. Dalton’s Tie Guy, many of the money people I’ve met with have raised the kind of objections that force me to defend the industry in general and myself in particular.

Such fears should be partially placated by a surprising improvement in auto loan portfolio performance in the past year. In working to form a new auto finance company, my associates and I researched the correlation between unemployment rates, investment inflows and defaults in asset-backed securities (ABS), as well as other consumer debt and portfolios of automotive retail installment contracts (RIC).

For data, we looked at the performance of ABS as rated by Standard & Poor’s from the year 2000, static-pool analysis of a portfolio of 5,000 RIC spread over Florida, Texas and the Midwest, unemployment data as published by the U.S. Department of Labor, and statistics on issuance of ABS domestically and globally as published by S&P and the Bank of England.

Our first set of data compares U.S. national unemployment rates and changes in the rates with defaults on ABS in the 12th, 24th and 36th months as traced by S&P:

Other data of equal interest compared the same default rates for ABS issued against many categories of consumer loans including student loans, credit cards, home loans and other loans. You see rather wild fluctuations in the investment climate over the past five years:

If you graph out the default rates among different ages of ABS, there are definitely some changes. But take a look at the difference in capital flows over four years. We included the general data on all ABS issuance because subprime auto is a large and fragmented industry. It’s often difficult to determine how much of an effective proxy the rated ABS issued on Wall Street is:

We find that the general unemployment rate is highly correlated with ABS and RIC portfolio defaults in the first, second and third years. However, the rate of change of unemployment is correlated in the first two years and negatively correlated in the third year.

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