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Rebound in Used Vehicle Values Benefits U.S. Auto Lease ABS, Says Fitch

October 15, 2009

CHICAGO — The resurgence of the United States wholesale vehicle market in 2009 has reversed the trend of heavy residual value (RV) losses on leased vehicles in late 2008, and steadied the performance of U.S. auto lease ABS transactions, according to Fitch Ratings.

As a result, Fitch has observed growth in credit enhancement levels across all Fitch-rated auto lease ABS in the past year, despite heavy RV losses in 2008. These increases in credit enhancement enable the transactions to support larger amounts of potential future RV losses, which Fitch views as the primary risk to auto lease ABS. It should be noted that elevated credit default levels will likely continue and some seasonal deterioration in RV performance in the next several months is likely to occur.

That being said, Fitch anticipates vehicle values to remain well above 2008 lows through next year due to positive supply factors. “Improving asset performance and the transactions' structural strengths, such as non-declining credit enhancement targets, will result in stable rating performance for U.S. auto lease ABS in the near term,” said Director Brad Sohl.

In 2008, volatile fuel prices, a challenging economy, concerns about the stability of U.S. auto manufacturers and other macroeconomic factors led to a significant decline in demand for used vehicles. By November 2008, WA monthly residual losses on Fitch's portfolio of rated auto lease ABS had surpassed 20 percent of the securitized residual value. Similarly, in December of 2008 the Manheim Used Vehicle Value Index published by Manheim Consulting, which measures wholesale used vehicle prices on a mix, mileage and seasonally-adjusted basis, dropped to a 13-year low of 98.

Since January of this year, used vehicle values have increased significantly. As of September 2009, the Manheim Index reached 118.5, an increase of 6.95 percent year over year and of 20.9 percent compared to December's low. Residual loss rates on Fitch rated auto lease ABS mirrored this improvement, as vehicle dispositions on the total portfolio in August resulted in nearly 10 percent gains of securitized residual value, compared to the losses of over 20 percent less than a year ago.

The stabilization of residual performance on most U.S. auto lease ABS has served to rebuild credit enhancement facilities that were drawn upon during the turbulence of 2008. “The building of these credit enhancement levels serves to protect the issued notes from the potential for future residual losses should vehicle values deteriorate significantly,” said Sohl.

In response to the improvement in asset performance and residual loss coverage levels, Fitch recently upgraded certain outstanding auto lease ABS. And while Fitch expects some seasonal deterioration in the coming months, it said RV performance outlook for the near- to mid-term is positive, even considering potentially weak demand. The drop in new vehicle sales is expected to limit the number of traded-in vehicles available for purchase. Similarly, the decline in leasing penetration combined with lower fleet rental volume experienced in 2008 and 2009, will also contribute to fewer off-lease vehicles.

Fitch remains cautious as vehicle values and realization rates remain subject to consumer demand factors linked to the health of the overall economy, as well as factors such as volatile fuel prices. Additionally, credit defaults are expected to remain elevated as unemployment continues to drag performance down.

However, the positive asset performance outlook for vehicle values leads to Fitch's Stable Outlook for all 'AAA'-rated auto lease notes. Similarly, subordinate auto lease ABS notes carry either Stable or Positive Rating Outlooks, with one class currently on Rating Watch Positive. The structural strengths of non-declining credit enhancement targets combined with a relative very short asset life, which results in rapid increases in loss coverage levels, contributes further to Fitch's view of stable near-term rating performance for the sector.

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