Fitch: Higher Rates May Pressure US Auto Subprime ABS Long Term

NEW YORK--(BUSINESS WIRE)-- Rising interest rates could pressure US auto ABS transactions, especially first on subprime deals, Fitch Ratings says. While last month's initial rate increase is expected to only have a marginal near-term impact on borrowers, the Federal Reserve plan to raise rates gradually over four years could increase the monthly debt burden on auto loan borrowers.

Although the rate increases are expected to affect the entire market, Fitch believes subprime borrowers may face a greater financial burden within this environment as they are more exposed to stagnant wage growth and have a weaker history of financial stability.

Any economic setback would touch subprime borrowers first even though the US employment rate has sunk to 2007 levels. Despite slight upturns in 2015, wage growth has largely been stagnant over the past five years and hasn't matched inflation or housing prices. Should this trend continue, wage growth for certain consumers may not match the Federal Reserve's planned increases. Over the past five years, consumers have taken advantage of low rates to prepay loan balances. With higher interest rates, greater higher prepayment rates become less feasible and may prolong loan terms. The household debt-to-income ratio could also increase, creating less discretionary cash available to pay down auto loan balances.

In this environment, auto loan originators could be forced to increase extended-term lending or incentive spending to keep monthly payments at affordable levels for US consumers. Extended-term contracts are already a raising concentration in ABS pools that hinder asset performance over time and typically perform weaker than standard-term 60-month or less auto loans. Loss severity on extended-term contracts is high since defaults typically occur earlier in the life of a loan when the borrower has little to no equity in the vehicle.

Over the past five years, the auto ABS market has largely been buoyed by a robust used vehicle market that will remain healthy in early 2016. However, Fitch expects vehicle values to be pressured due to increased supply over the next few years, contributing to lower recovery rates. In December, Fitch's auto ABS annualized net loss (ANL) indices reached 0.60% and 9.20% for prime and subprime, respectively. If defaults increase due to higher interest rates in a weaker wholesale market, Fitch expects both the prime and subprime ANL indices to climb higher.

Additional information is available on www.fitchratings.com.

The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article, which may include hyperlinks to companies and current ratings, can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.

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View source version on businesswire.com: http://www.businesswire.com/news/home/20160104005876/en/

Fitch Ratings
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Source: Fitch Ratings

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