NEW YORK -- U.S. credit card and auto ABS could withstand significant increases in unemployment from current levels before 'BBB' or 'AAA' bonds default, but downgrade risk persists, particularly at the subordinate level as unemployment levels have increase substantially over the past 12 months, according to a new Fitch Ratings report.
Fitch recently completed a study analyzing the sensitivity of consumer ABS losses to changes in the U.S. unemployment rate in response to the continued weak economy, along with increasing worries about consumer ABS performance. The unemployment rate is a widely acknowledged indicator of consumer financial health.
Fitch's study, which focused primarily on the level of unemployment that would cause first dollar defaults in auto loan and credit card ABS transactions, determined that typical 'AAA' rated transactions could withstand an increase in the unemployment rate of up to 20 percent, all other factors being equal. In addition Fitch determined that typical 'BBB' rated transactions could withstand an increase in the unemployment rate of up to 10 percent, again with all other factors being equal.
"Most credit card and auto ABS bonds can withstand a major unemployment shock before a loss occurs, but it does not mean they are immune to downgrade," said Kevin Duignan, managing director and head of Fitch's U.S. ABS group.
Fitch's study also focused on how quickly unemployment rate shocks translate to ABS losses and the differences between auto loan & credit card transaction performance during the unemployment shocks. The effect of rising unemployment on auto and credit card performance tends to lag the actual rise in unemployment by three to six months.
Additionally, consumers are more likely to default on credit cards before auto loans following a shock to unemployment. "Given the recent jump in unemployment, Fitch expects credit card and auto loss indices to continue climbing in the third and fourth quarter of this year," said Don Powell, senior director at Fitch.
The actual ability of individual investment grade securities to withstand losses is also contingent on many other factors including origination and servicing quality, transaction structure and specific asset characteristics. "In a high unemployment environment, it is likely that weakness in a number of additional economic factors will amplify losses beyond those directly related to employment," said Ebru Demir, director at Fitch.