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Automation Marches On: Do Jobs Need To Be Collateral Damage?

It's a familiar refrain in campaign rhetoric, around the Thanksgiving dinner table, and pretty much anywhere on the internet: (Country name) is stealing American jobs!

But is that commonly held view true? S&P Global suggests that the answer isn't so black and white. While unfavorable trade dynamics have resulted in lost jobs in a number of industries, automation and the industrial adoption of advanced technologies have a further-reaching impact on the state of the U.S. labor market (albeit without an expected boost to productivity of late).


  • Along with trade dynamics, automation has led to job loss in a number of industries.
  • Technological advancement's far-reaching impact includes U.S. trade in services and the type of jobs created.
  • Focused education initiatives and skills training will help tackle job loss, particularly among displaced workers, and address slowing productivity. With job openings at a record high, the inability to fill openings points to a lack of qualified candidates and gets to the heart of why there's been persistently low productivity growth.
  • S&P Global Ratings' economists found that if the U.S. adds one more year of education to today's workforce over a five-year period, the productivity boost to the economy would add an additional $325 billion or 1.8 percentage points to potential GDP.
  • Government balances also have a bit more breathing room: With an increase in workforce education, the federal deficit will be $92 billion narrower by 2021 versus the baseline.

Some argue that it's only a matter of time before machines take all our jobs; others believe that while the disruption is painful, civilization has seen this before and, over time, has learned how to adapt to change and come out ahead, though this could take decades, not months.

But, for now, one way to help tackle the problem of lost jobs and slowing productivity today is education, including teaching new skills to potentially displaced workers. Preparing older, more seasoned employees for a new tech-savvy world may not only help their job security prospects but also give economic productivity a boost as these workers combine their years of expertise with new technological skills.

Furthermore, it's not just a manufacturing story. The adoption of advanced technologies has affected employment conditions in a number of other industries--from restaurants and retail to construction, finance, law, and even accounting.

For many Americans worrying that robots will soon take their jobs, these fears are well founded. Low-paying jobs and those that require less education are often the most vulnerable to being replaced by a machine. But, even those who don't lose their jobs to technology may see a (perhaps welcome) change in their responsibilities. Workers in highly skilled jobs reportedly spend more than 30% of their time doing routine work, and automation may free up time spent on manual or routine work so that they can focus on more essential or strategic duties.

Overall, we at S&P Global see automation as both a problem and a solution for job creation in the economic future. We argue that a better way to look at the effects of automation may be to understand how jobs could evolve with technological progress, and what kinds of education and (re)training may help employees succeed in a future where they work side by side with colleagues that are made of nuts and bolts rather than flesh and blood.

Trade…And Trade-Offs

We can't ignore the fact that, for many manufacturing industries, trade has been responsible for lost jobs.

The number of U.S. manufacturing jobs shrank 36.6% from its 19.6 million peak in June 1979--to 12.4 million in May 2017. To give context, manufacturing jobs accounted for 24% of total jobs in 1974. It's now 8.5%. And while this figure bottomed out in 2010, at 11.5 million (with manufacturing jobs growing 8.3% in the ensuing seven years), certain industries have fared far worse than others. Among those with declining employment from 2011-2016, apparel suffered the most, losing 12.8% of positions according to the Bureau of Labor Statistics (BLS). In fact, from 1991 to 2016, the apparel industry shed 85% of its jobs, and employment at textile mills tumbled 76%. Hence the appeal of trade restrictions to shore up these and other industries--primarily through taxes and tariffs that would make imports more expensive.

Many associate these job losses with the importation of cheap goods and the labor associated with their production. However, the number of job losses directly caused by cheap imported goods represents a small fraction of the normal churn of U.S. labor markets. According to a January 2016 research paper, "Import Competition and the Great US Employment Sag of the 2000s," by Daron Acemonglu, David H. Autor, David Dorn, Gordon H. Hanson, and Brendan Price from the Journal of Labor Economics, imports from China displaced as many as 985,000 workers in American manufacturing industries and 1.98 million workers in the entire economy from 1999-2011--depressing local labor markets in communities that produced such goods as textiles, apparel, and furniture, with interindustry linkages magnifying the employment effects from the trade shock. But while the loss of nearly 1 million manufacturing jobs and 2 million total in a decade is significant, the U.S. labor market records about 1.7 million layoffs and discharges and about 5.25 hires every month under normal conditions in a jobs market that employs around 150 million people.

Furthermore, blaming trade in consumer products from countries such as China is misguided, given that the vast majority of what is sold in the U.S. is produced domestically. An August 2011 report from Galina Hale and Bart Hobijin at the Federal Reserve Board of San Francisco found that "Made in China" goods represented just 2.7% of U.S. personal consumption expenditures in 2010, with less than half of that figure, only 1.2%, reflecting the actual costs of Chinese imports. The rest of the money spent on that product goes to U.S. companies and workers in the form of U.S. transportation, wholesale, and retail activities. Updating that analysis to 2014, S&P Global found similar results. Goods with the "Made in China" label accounted for just 1.9% of U.S. consumer spending (about one-fifth of the 10.3% foreign share), with only 0.9 percentage points of that total reflecting the cost of the goods. Thus, for every dollar spent on such items from China in 2014, 53 cents go toward services provided by companies in the U.S.

Meanwhile, the costs that would come with protecting a certain segment of the labor force could outweigh the benefits. In his June 2016 paper "The Truth About Trade," Dartmouth College social sciences professor Douglas A. Irwin examined the effects of increased isolationism. He cited the fact that, while few Americans are employed in the manufacturing apparel industry (124,000 jobs in May 2017), more than 45 million U.S. residents live below the poverty line. As such, it's difficult to see the economic benefits of increasing clothing prices for 45 million low-income Americans (as well as everyone else) in an effort to save just some of the jobs in an industry that accounts for roughly one of every 1,000 full-time jobs in the U.S. labor force. We only need to think of what a 45% tariff would do to the price of a new pair of Chinese-made shoes to get the picture.

We agree that the potential costs of increased isolationism would far outweigh the benefits of protecting American businesses in such a manner--potentially igniting international tensions and ignoring the benefits U.S. consumers get in the form of more product choices at lower prices (which helps lower-income households most, of course). It's worth noting that trade now represents 27% of U.S. GDP (in 2016 nominal terms), up sharply from 16% during the Reagan Era--with the U.S. getting more imports from China and Mexico (together, 35%) than any other country. Slapping tariffs on these goods and services would likely benefit only a small fraction of American workers and would hurt consumers and producers that rely on imports for inputs. Given that 11.5 million jobs, particularly transportation jobs, were supported by American exports last year (7.7% of total U.S. jobs), retaliatory tariffs on U.S. goods and services would clearly be detrimental to a number of these workers.

Rounding Up The Usual Suspects

During the 2016 U.S. presidential campaign, the poster child for struggling American manufacturers was the unemployed factory worker, with trade the culprit. And it's true that manufacturing has lost more than 7 million jobs from its peak of 19.6 million in June 1979. But in contrast to claims that manufacturing is in freefall, U.S. manufacturing production is near all-time highs (see chart 1). Although the Great Recession brought about a sharp decline in manufacturing production and significant job losses, the country's manufacturing remains on a long-term growth path (in inflation-adjusted dollars). In fact, from 2010-2016, U.S. manufacturing output grew 14%, or roughly 2.3% annually--roughly in line with the economy as a whole, which expanded 12%, or 2.1% a year, during that period.

Ironically, when they are hiring, manufacturers (and other businesses) say that they can't find workers with suitable skills needed to complement their new production capabilities. Given reports that job openings are at all-time highs, the mediocre jobs report this May suggests that businesses are struggling to fill these positions in an increasingly tight market. Workers also appear to have given up. The labor participation rate is now at a 38-year low, with only around half of that drop likely because of retiring baby boomers.


Moreover, the lost manufacturing jobs were more the result of technological updates than trade. Indeed, "The Myth and the Reality of Manufacturing in America" June 2015 study by the Center for Business and Economic Research at Ball State University found that technological change--rather than trade--was responsible for 85% of that total. It noted that this should be viewed as an illustration of the impact of productivity growth, not actual lost jobs from productivity.

Definitions (Cambridge Dictionary)

  • To automate: to make a process in a factory or office operate by machines or computers, in order to reduce the amount of work done by humans and the time taken to do the work.
  • Artificial Intelligence (AI): the use of computer programs that have some of the qualities of the human mind, such as the ability to understand language, recognize pictures, and learn from experience.

In other words, manufacturers are producing more with fewer people. That helps explain why Deloitte found in its 2016 Global Manufacturing Competitiveness Index that U.S. manufacturing is now the second-most competitive in the world, behind China. But not for long. Deloitte expects U.S. manufacturing to surpass China by the end of the decade, largely thanks to increased productivity from advanced technologies.

The authors of the Ball State study, professors Michael J. Hicks and Srikant Devaraj, suggest that the dynamics of labor usage in manufacturing are contributing to the belief that the sector is in decline. They cite that, from 1998-2012, productivity expanded in all sectors (when adjusted for inflation and with significant sectoral variation) (see chart 2). This growth was led by computer and electronics, but double-digit gains were recorded in automobiles, transportation equipment, and primary metals machinery, among others.


In general, they found that, if productivity levels had been the same in 2010 as they were a decade earlier, the economy would have needed 20.9 million manufacturing workers. Instead, the country employed just 12.1 million. In this light, it's easy to see why there's so much hand-wringing about the state of U.S. manufacturing--and why many in Washington have seized on it as a hot-button issue.

Unfortunately, we've indicted the wrong guy: trade. Meanwhile, automation seemingly got off scot-free and is still at large.

At Your Service

And while many in Washington continue to point at China and Mexico as the culprits, it's worth bearing in mind that U.S. trade in services has been booming, thanks, in part, to technological change, with the cyber highway helping to pave the way.

As it stands, the U.S. maintains a strong and growing trade surplus in services (even as American companies increase their outsourcing of services such as customer call centers and tech support). According to the U.S. International Trade Commission's 2016 annual report, the U.S. continues to be the largest global exporter and importer of services in the world. U.S. services exports reached approximately $752 billion in current dollars, or 34% of total U.S. exports in 2016--up from around 20% before 1980--while imports of services were $503 billion, or 18.5% of total imports, according to the Bureau of Economic Analysis (BEA) (see chart 3). Services supplied by U.S.-owned foreign affiliates, the leading channel through which many American services are delivered to foreign markets, increased 3%, to slightly more than $1.3 trillion, in 2013 (latest available data).


The relative strength in American exports in services in the past 35 years or so, as compared with merchandise (both manufactured and agricultural goods) exports, reflects broader changes in the world's biggest economy--primarily that the share of services in GDP and employment has been steadily rising since the 1950s. Service industries (leisure and hospitality, retail trade and transportation, financial and insurance services, information services, business and professional services, etc.) now account for about 80% of the economy and employ more than 80% of the country's private-sector workers.

The emergence of the internet and the increased capacity to move data around the world at low cost have created entirely new export opportunities for services providers and America's small businesses. This growth in information technology and declining transportation costs have facilitated the surge in the trade of services, especially in digitally deliverable services (those that are enabled and facilitated by information and communication technologies). These include business, professional, and technical services; royalties and license fees; financial services; insurance services; and telecommunications. Digitally deliverable services continue to be an important contributor to U.S. trade, accounting for more than half of all services trade and more than one-sixth of overall trade in goods and services, according to the U.S. Department of Commerce. The U.S. had trade surplus in digitally deliverable services of $160 billion. Because exports have increased at a faster rate than imports, the surplus has expanded by 19% since 2011.

Extending Ball State's illustrative exercise on productivity changes and job formation to the service sector, S&P Global found that growth in real production per worker has been meaningful since 2000. Applying 2000 levels of real production per worker to 2016 levels of production in the service sector, S&P Global found that it would have required 134 million workers to produce 2016 levels of real production. Instead, the economy employed 110 million workers. While service sector employees expanded by 15% during this period, total output increased by 41%, with a 22% average rise per worker. The manufacturing sector also saw significant production gains combined with a significant drop in jobs--with production per worker more than twice that for services. But, unlike the manufacturing sector, the service industry saw exports consistently grow more than imports, and thus global demand--through the trade channel--likely gave American service sector a positive boost, albeit small.

Jumping On The Bandwagon…Or In A Self-Driving Car

Advances in technology create jobs. For example, as cars started speeding along American roads, that probably wasn't the best time to gain expertise in shoeing and tacking up a horse or fixing a wagon wheel. On the other hand, opening a motel or a fast-food restaurant to serve motorists and truck drivers would have been a good career move.

Historically, technology ends up creating more jobs than it destroys because of how automation works, says M.I.T. economics professor David Autor in his 2015 report "Why Are There Still So Many Jobs? The History and Future of Workplace Automation."

Automation substitutes for labor so that a task can be done faster or for less cost. But many forget that automation also complements labor. It raises output in a way that leads to more demand for human workers to do the accompanying tasks that haven't yet been automated. Essentially, workers become the supervisors of machines.


In The Economist's June 25, 2016, special report "Artificial Intelligence: The Impact on Jobs," James Bessen, an economist and lecturer at the Boston University School of Law, highlights an example from weaving during the Industrial Revolution. While the introduction of machines to the textile industry initially led to lost jobs, the automation of more and more tasks in the process allowed workers to focus on things machines couldn't do, such as tending multiple machines to keep them running smoothly--thus boosting output. During the 19th century, the amount of coarse cloth a single American weaver could produce in an hour increased by a factor of 50, with the labor needed effectively disappearing--dropping 98%. Cheaper cloth increased demand for cloth, in turn creating more jobs for weavers, and their numbers quadrupled from 1830-1900.

In an example from our lifetime, it would have been easy to predict that ATMs would spell doom for bank tellers--and, indeed, the average number of tellers at an average American bank branch fell to 13 in 2004 from 20 in 1988, Mr. Bessen notes. However, the cost savings allowed banks to open more branches to meet customer demand--and the total number of bank employees increased. Rather than resulting in a net loss of positions, the implementation of ATMs allowed bank employees to spend less time on routine tasks and more on activities, such as sales and customer service, that machines couldn't do.

The automobile was another technological advancement that changed the way the economy ran. Sure, horse-and-buggy drivers were out of business. But the introduction of the automobile opened the door to many new industries, including motels, fast food, and even drive-ins. Today, with the driverless car becoming more and more a reality, it's hard not to wonder what will the economy look like in 10, 20, or even 50 years.

With that in mind, it's important to remember that a large--and fast-growing--contingent of American workers will be displaced by technology. Around 3% of all working Americans are drivers of some sort--the majority drive trucks while others drive taxis or buses. A CNBC article (Sept. 2, 2016) notes that these jobs aren't evenly distributed across the country, and some places are going to be hurt more than others. All you have to do is look at the sea of yellow cabs on Broadway in New York City to understand how disruptive that could be.

And while retail may not be at the top of the list of industries where the use of automation is commonplace, that does not mean that automation in retail isn't happening. Robert Schulz, at S&P Global Ratings, says "The great retail disruptor ecommerce, as dominated by Amazon, is a widespread form of automation, notably on the consumer-facing front-end of a retail purchase. Amazon is already testing the friction-less checkout, which goes beyond simple self-checkout." But, "on the back end, much of the order processing involves robots picking goods, if not yet packing. And the sorting and shipping process is a mix of automation and human workers."

In the restaurant segment, mobile ordering and mobile pay, a form of automation, are increasing penetration. Tabletop digital order and pay in casual dining is also increasing.

So while self-driving cars and drones are not yet delivering retail goods (which have been picked and packed by robots), over the final mile it's safe to say that use of automation in the front and back-end of the retail experience is on the rise.

For Self-Driving Cars, The Question Is: How Soon Is Soon?

While it seems clear that, sooner or later, roadways around the world will be lousy with self-driving cars, significant hurdles--some technological, some philosophical--may mean that "later" is the more likely scenario.

As it stands, there are a number of technological paths being considered, and carmakers themselves can't seem to agree on whether to collectively pursue the types of vehicles that are truly autonomous--i.e., without any possible intervention from the driver--or those in which steering wheels and gas pedals can still be controlled by a human being.

That said, various real-world trials, such as Uber Technologies' experiment with driverless cars in Pittsburgh and Google's extensive testing of autonomous vehicles, suggest that a world in which everyone is a passenger is just around the corner. And while the wide-scale adoption of auto-related innovation has sometimes come in fits and starts (consider the example of backup cameras, which took more than a decade to go from development to full assimilation), advances such as adaptive cruise control, blind-spot warning alerts, and advanced emergency braking systems are all contributing to the development of autonomous vehicles.

Meanwhile, questions of legal liability also pose some hurdles. While figures on the U.S.'s National Transportation Safety Board website suggest that 94% of vehicle crashes are due to human error, and the group works to sort out the rules and regulations for autonomous driving, it remains to be seen whether the makers of such vehicles are prepared to assume legal responsibility when the cause of a crash is outside the human realm.

Beyond that, perhaps the greatest challenge companies face lies in getting consumers to accept the idea of ceding total control to machines that will cart them around at highway speeds. While consumers are generally happy with collision-protection technologies--in fact, they have produced the highest level of satisfaction in some J.D. Power studies--more than one-fifth of car owners have trouble using or understanding their vehicle's safety features. Add to that the risk of confusion caused by the variability of marketing names and acronyms for similar systems, differences in default settings, and the difficulties drivers may encounter when switching from one system to another, and it's clear that manufacturers have their work cut out for them.

As such, car dealers may play a big role in smoothing the way for wider acceptance of autonomous vehicles--once manufacturers can guarantee that fully functional designs exist, of course.

Either way, younger Americans are, unsurprisingly, more open to the idea of autonomous vehicles than older generations are. This is especially important because millennials will soon be buying more cars than any other generational cohort. According to J.D. Power surveys, Gen-Yers are twice as likely to trust fully automated self-driving vehicles as Gen-Xers are and five times as likely as baby boomers are.

But there also seems to be a disconnect between the general sentiment about self-driving and the actual act of being driven in such a vehicle. While 67% of 16-to-21 year olds have said they are very or somewhat positive about the idea of autonomous vehicles, 85% of them reported being somewhat or very concerned about the idea of actually traveling in one. Foremost among their concerns is the fear that the vehicle could be hacked or hijacked in some way. Moreover, the multitude of scenarios that a self-driving car could encounter while operating among a mix of autonomous and driven vehicles could make for significant growing pains.

(Editor's note: The preceding was adapted from "Global Automakers Are Scrambling For Position As The Market Evolves, Conference Speakers Say," published Nov. 2, 2016, on RatingsDirect.)

Welcome To The Machine

While debate continues about how soon machines will have the broad intellectual capabilities that humans do, one thing seems inarguable: Technology will continue to match and exceed human performance in more and more tasks. It doesn't take much imagination to realize that, at some point in the not-too-distant future, nearly all routine functions will be done by machines (with the operative word in that assessment being "routine").

As such, technological progress that allows output to increase faster than labor and capital is--and will be--the main source of per capita economic growth. Naturally, this comes with some caveats. While automation will continue to create wealth and add to GDP in coming years, that growth will come with a cost, changing the skills that workers need to succeed. In a December 2016 report, President Obama's office argued that aggressive policy action would be needed to help workers who are disadvantaged by this transformation, as well as to ensure that the benefits of AI and automation are available to all citizens.


Somewhat counterintuitively, all of these technological advances haven't seemed to boost recent productivity growth in any significant way (see chart 5). In fact, productivity growth in the past decade has slowed in almost every advanced economy, and the U.S. is in one of its slowest-growth periods since the end of World War II (see "The Strange Case Of Shrinking U.S. Productivity Growth: Myth, Mismeasurement, Or Multiyear Phase?," published May 5, 2016).


During the current expansionary period, which started in the fourth quarter of 2007, labor productivity has increased at an annualized rate of just 1.1%, according to a January 2017 report from the BLS. That's well off the rates of the 10 business cycles since 1947--and only a brief, six-quarter cycle in the early 1980s saw a rate that low (also 1.1%). So, while the U.S. has seen an amazing surge in technological innovation and efficiency gains, that productivity boost remains out of grasp. As the San Francisco Fed Senior Advisor John Fernald frames it, according to the Financial Times on May 3, 2016, if the robots were taking over, "we would see lots of capital growth and not much labor growth." If the U.S. was seeing a surge in automation, labor productivity and capital investment would also be growing at a rapid pace, as fewer workers and more technology did the work. Instead, we've seen a deceleration.

That said, it's not inconceivable that productivity growth will accelerate sometime soon--if not in the immediate future--and to the extent that automation fosters positive advancement in diverse sectors, Americans will be better off in the aggregate. S&P Global thinks productivity will likely improve in the coming quarters, at least moderately, as the economy reaches full employment--which recent data indicate we're near.

There is a real risk of hysteresis--the process through which low resource utilization leads to persistently weaker productive potential--for the economy as drawn-out cautiousness with business investment could weigh on productivity through capital-embodied technology. But, proper demand stimulus (businesses' confidence that they can sell more goods), together with a mix of policies to address structural headwinds, such as the slow diffusion of technology, a mismatch in skills between workers and positions, and a declining share of entrepreneurial businesses, will expedite a return to the little over 2% productivity growth from 1950-2007.

Don't Fear The Reaper Or The Robot…Learn How To Operate It

Human fears about the rise of technology are nothing new--after all, the legend of "steel-driving man" John Henry dates back to at least the 1870s. (And, sure, he won the race against the steam-powered hammer, but who among us would pay such a price to do so?) Meanwhile, Luddites were originally a group of early-19th century English textile workers who destroyed machinery as a form of protest (taking their name from an apprentice, Ned Ludd, who, according to legend, smashed two knitting machines in 1779).

In today's economy, workers who are most threatened by automation are often those who are lower paid, lower skilled, and less educated (see chart 6). According to the Council of Economic Advisors, jobs for people with less than a high-school degree have a 44% chance of being replaced by automation; for low-paying jobs (less than $20 per hour), it's 83%. By contrast, a job that requires someone with a bachelor's degree has only a 6% chance of being automated; for high-paying jobs (more than $40/hour), it's only 4%.


That doesn't mean that a low-paying job is, by its very nature, apt to be cut. Technical feasibility is a necessary precondition for automation. But even assuming a job can be automated, other factors are important. For example, if an employee makes a low wage, investing in a comparatively expensive robot may not provide sufficient return on investment. At the same time, social skills still matter. While an iPad or TV may be able to entertain a child, most parents would still prefer to leave their children in the care of a human childcare worker than a robot.

Automation is also changing responsibilities for skilled jobs. Highly skilled workers (whose annual incomes exceed $200,000) spend more than 30% of their time on routine tasks (25% for CEOs) that could be automated, according to a January 2017 report by McKinsey Global Institute. Automation would free up time for such employees to engage in more intellectual pursuits, which would add to their businesses' bottom lines.

Re-Upping On Humans

In this light, it's important to remember that, while robots may be taking work from us, they aren't our enemies. We agree with the 2016 report from the president's office that starts with the premise that investing in and developing AI is something that we, as a society, need to do. But the report also suggests that we need to educate and train Americans for the jobs of the future--and help those who have been left behind in the transition. As the report notes, empowering workers would ensure broadly shared growth.

Along these lines, Bill Gates has argued for a "robot tax," saying he thinks that governments should levy companies' use of them as a way to fund other types of employment. In a February interview with business-news website Quartz, Mr. Gates said that such a tax could help finance jobs for which humans are particularly well suited, such as assisting with elderly care or working with kids in schools. The piece quoted Mr. Gates as saying: "Right now, the human worker who does, say, $50,000 worth of work in a factory, that income is taxed and you get income tax, Social Security tax, all those things. If a robot comes in to do the same thing, you'd think that we'd tax the robot at a similar level."

Setting aside the manner in which it would be financed, S&P Global agrees that re-education is the key factor to consider. Given many businesses complain that they can't find workers with the skills they need in this new economy, they would likely agree.

Still the central question is: Can American workers keep up with the pace of change? And can we afford not to offer reeducation and training to the workforce if we want to see sustainable economic growth?

Retraining seasoned workers with the tools they need in a new automated society would keep them--and their experience--in the jobs market. That means their knowledge of their businesses wouldn't be lost to the next generation, as they could train the younger workers. Naturally, they'd also be making an income to help themselves and their families. The increased economic activity would also mean more tax revenue for Uncle Sam, which would help pay for retirement benefits as the baby boomers leave the workforce.

America, Back To School

The U.S. has been through this transition before--and not so long ago. Roughly half a century ago, from 1960-1965, the U.S. workforce gained a year of education, surpassing the period from 1950-1980, when Americans gained an average of about eight months of education every five years. And in the early part of the 20th century, when automation of the U.S. farm left many out-of-work farm hands migrating to cities, agriculture states were the first to institute universal public high school education to prepare for the future. The G.I. bill at the end of War War II turned many a war veteran into a college graduate.

In fact, our research shows that, if the U.S. were to add another year of education to the American workforce, GDP would likely be $325 billion, or an aggregate 1.8%, higher in five years than in our baseline forecast (see chart 7). During the five-year period, labor productivity growth would be up by 0.2 percentage points on average than in our baseline case. While our scenario doesn't specify by type of education, targeting an area such as the gap between technological change and worker skills may have even more immediate productivity gains.

In our hypothetical scenario, this translates to about 755,000 more jobs in the next five years in the economy. Higher capacity for growth in both labor and products markets together add more room for more cyclical growth, as well as higher rate of growth in the economy, and also provide more breathing room for government balances as the federal deficit would be $92 billion narrower or, as a percent of GDP, 0.4 percentage points lower (3.67% versus 4.04%). This is a meaningful boost to the overall macroeconomic conditions of the economy, considering the recovery that has been dogged by hysteresis (a persistently weak growth environment compared with previous cycles) during the present business cycle.


Historically, data at the state level support these results. A clear and strong correlation exists between the education of a state's workforce and median wages, with better-educated individuals more likely to participate in the job market and earn higher wages and less likely to be unemployed. Nationally, the unemployment rate for people 25 years and older with a college degree was 2.4% in April 2017--one-third of the unemployment rate for those with less than a high-school degree. According to our research, education is an investment in the health and livelihood of future generations, with greater parent education positively correlated to a child's health, cognitive abilities, academic achievement, and future economic opportunities (see "How Increasing Income Inequality Is Dampening U.S. Economic Growth, And Possible Ways To Change The Tide," published Aug. 5, 2014).

Evidence indicates that a well-educated U.S. workforce is not only good for today's workers and their children but also for the economy's potential long-term growth rate and government balance sheets--what do we need to do to reach these levels?

We'd argue that a degree in a STEM (science, technology, engineering, and math) field is often not necessary to bring many workers up to speed. Instead, simply increasing technological literacy could be the ticket to bring back workers displaced by automation. It's also easy to assume that a more tech-savvy employee--albeit with less industry experience--would do the trick. But that ignores the years of industry experience a seasoned employee brings to a firm--even when that worker is technologically challenged.

Holding onto older workers may also benefit society as a whole. Data on labor dynamics reaching back to the 1980s indicate that many men of prime working age (25-54) have been dropping out of the labor force (now women, age 25-54, are also leaving the market) (see chart 8). However, productivity climbs higher with age, until it peaks at age 50, when productivity is 60% greater than someone who's 20 years old (Wall Street Journal "For Economy, Aging Population Poses Double Whammy," Aug. 3, 2016). So, for the benefit of the U.S. economy, we need those people of prime working age back to work!

A paper by Nicole Maestas of Harvard University and Kathleen Mullen and David Powell of the Rand Corporation found that a 10% increase in the share of a population over age 60 decreases the growth rate of GDP per capita by 5.5%. One-third of that drop was from slower labor force growth as the workers retire.

But two-thirds of the reduction was due to slower productivity from the remaining workers. That older worker's experience was not only increasing his own productivity, but also that of those who work with him. With him gone, that associated drag on productivity means lost potential economic growth both today and tomorrow. Whether the U.S. reverses that trend could spell the difference between continued ho-hum growth, or an economic renaissance for the 21st century.


Change Is Inevitable--Progress Is Optional

As with all "creative destruction," the advent of scalable automation technologies and global value chains continues to generate winners and losers. And if 30 years of evolution in the manufacturing sector has taught us anything, it's that effective retraining measures must be put in place to catch workers likely to fall through the cracks, either temporarily or permanently. Efforts need to be taken to reduce skills mismatch in the labor market--and the burden lies in both the public and private domains (see "Better Job Skills And A Good Education Are Two Sides Of The Same Coin," published Aug. 27, 2014).

As information technologies have radically changed work in a wide variety of occupations--from construction to finance--in the past few decades, many employers have had persistent difficulty finding workers who can make the most of these innovations. This is one reason businesses are working now to reskill the workers U.S. businesses need to thrive. According to the Harvard Business Review (HBR) October 2016 report "AT&T's Talent Overall," the company plans to reinvent itself and re-skill its current employees to keep pace in this rapidly changing world. HBR says AT&T's gambit to reeducate its "enormous workforce is without precedent." Let's hope they succeed.

For policymakers, ensuring that all individuals are furnished with better and more relevant skills is vital for expanding the productive base of an economy. Simply put, those workers who acquire the latest skills earn good pay; those employers who hire the right workers and train them well can realize the competitive advantages that come with new technologies. Policymakers need to think differently about skill--encouraging, for example, industry certification programs for new skills and partnerships between community colleges and local employers. This would produce not just more college graduates, but also graduates with the skills employers want. Perhaps lawmakers could ease excessive occupation licensing regulation and make licenses transferrable across states for greater labor-market fluidity.

Meanwhile, for firms looking to capitalize on productivity gains from new technologies, increasing in-house training and apprentice programs--often teaming up with government agencies, unions, and colleges--would go a long way toward finding the right people for the positions. This also would help employees redefine their jobs within the company or industry, protecting against job losses or underemployment.

Evidence of a skills mismatch in the U.S. labor market can be seen in the fact that there are more job openings (a record high 6.04 million) than hirings (5.05 million) on the last business day in April 2017, eight years into the U.S. expansion. The inability to fill openings points to a lack of qualified candidates and gets to the heart of why there's been persistently low productivity growth. At the same time, the ramifications of all this aren't confined to the U.S.

On a global scale, increased automation could mean that low-wage countries that once attracted manufacturers lose their cost advantage, as well as the accelerated economic expansion that often comes through shifting workers to factory jobs. In a January 2016 survey of institutional clients, Citi found that 70% believe that automation and the developments in 3-D printing will encourage companies to move manufacturing processes closer to home--with North America gaining the most from this development, while other emerging markets, like China, having the most to lose. Citing the 2016 World Bank "Digital Dividends" report, World Bank President Jim Yong Kim said this April that, "we estimate that two-thirds of jobs that currently exist in developing countries will be wiped out by automation." While how fast automation will cut jobs is unclear, he noted that we need to think about "the investments we need to make right now, in order to prepare ourselves for the economy of the future."

Writer: Joe Maguire

COP24 Special Edition Shining A Light On Climate Finance


− Green loans are evolving, with the Climate Bond Initiative forecasting nearly $1 trillion in green bond issuance by 2020.

− Despite the uptick in green bond and loan issuance, the market still remains relatively small, especially compared to the universe of assets comprising CLO 2.0 transactions.

− In our view, a green CLO market has large growth potential, boosted by regulatory initiatives and emerging interest from both issuers and investors in 2018.

− We built a hypothetical rating scenario for a green CLO to compare and contrast the underlying portfolio and structure with a typical European CLO 2.0 transaction.

− Our hypothetical green CLO analysis showed that green loans may have different fundamental characteristics to corporate loans, such as lower asset yields, higher credit quality, and higher recovery rates assumptions.

The global collateralized loan obligation (CLO) market has experienced a rebirth (2010 in the U.S. and 2013 in Europe). New issuance continues to increase due to investor familiarity with the product, as well as low historical default rates. While a market for green assets, such as green loans and bonds has been established for a while, although still of a relative size, a sustainable securitization market is still in its infancy. Considering the challenge in financing the amounts, S&P Global Ratings expects green CLOs to play a role in increasing the private sector presence in the sustainable finance market.

Following the Paris Agreement that came into force in November 2016, 184 parties have ratified the action plan to limit global warming. For this purpose, developed nations have pledged to provide $100 billion (about €87 billion) annually until 2025. As part of this deal the EU has committed to decrease carbon emissions by 40% by 2030. In March 2018 the European Commission (EC) proposed the creation of environmental, social, and corporate governance 'taxonomy', regulating sustainable finance product disclosures, as well as introducing the 'green supporting factor' in the EU prudential rules for banks and insurance companies.

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Energy: What to Watch in 2019


S&P Global Platts Analytics Issues Two Special Reports

Pricing across the global energy markets will face headwinds in 2019, with a weaker and more uncertain macroeconomic framework deflating price formation in general, according to two special reports just issued by S&P Global Platts Analytics. Such headwinds will require the industry and portfolio managers to take a big-picture approach.

See the Executive Summary of the S&P Global Platts Analytics special report 2018 Review and 2019 here. Access the full S&P Global Platts Analytics Top Factors to Look Out For in 2019 for Energy here.

"One of the key lessons learned in 2018, painfully by some, is that market sentiment can shift violently without much change in fundamentals, requiring a steady, holistic perspective," said Chris Midgley, global head of analytics, S&P Global Platts. "It is clear that this volatility will remain a feature across the energy markets in 2019, particularly as IMO 2020 nears."

Particularly blustery headwinds are in store for markets where prices finished 2018 at elevated levels, and well above costs, such as North American natural gas and global coal. However, if the supply side can adjust to the reality of slowing demand growth, energy prices can find support. For natural gas liquids (NGLs), the ongoing logistical constraints at the US Gulf Coast are likely to manifest on continued price volatility, particularly for ethane and liquid petroleum gas (LPG), over the next year despite strong global demand.

LPG, such as propane and butane and used in transportation fuel, refrigeration, heating and cooking, is rapidly facing US export capacity constraints, especially along the US Gulf Coast. For LPG feedstock propylene, there is clear potential for high volatility globally over the next 12-18 months.

Analysts at S&P Global Platts see weakening prices of Henry Hub natural gas. The slowdown in US demand growth will exceed that of supply. But if winter temperatures prove to be colder than normal, near-term prices will need to move higher to bring on enough supply to replenish depleted storage levels.

For global liquefied natural gas (LNG), it will be end-user-backed LNG demand that faces particular struggle to cope with the speed and force of new supply entering the market in 2019. Non price-responsive demand in Asia will be easily met and JKM spot physical prices (reflecting LNG as delivered into Japan, Korea and China) will sag next year.

Access the full S&P Global Platts Analytics Top Factors to Look Out For in 2019 for Energy here. Among the 22 key take-away themes:

  • NGL supply growth will strain the North American energy system
  • Saudi Arabia will need to be nimble to balance 2019 oil supply
  • US oil supply limited by pipelines
  • Oil demand slowing: trade war, industrial slump
  • 2019 LNG supply additions largest since the Qatari mega-trains
  • US gas supply growth to exceed demand growth even with LNG exports
  • Global solar growth slowing
  • Shipping disruption looming - IMO 2020
  • New Russian gas pipeline advantage over Ukraine
  • US coal demand to decline again in 2019
  • Growth in new refineries and complex capacity likely to weigh on refinery margins especially in Asia

Year 2019 will certainly be one of transition for crude and refined oil products as it will lead into 2020 when roughly three million barrels per day of high-sulfur fuel oil must be “destroyed” (including enhanced usage of HSFO in power generation) due to the International Marine Organization (IMO) mandate of eco-friendly shipping fuels in use at sea. A similar amount of middle distillate/low sulfur fuel must be created (by refinery changes and by running more crude oil. The increase in refinery capacity between now and 2020 is large, but mostly needed to cover normal demand growth. Expect prices of light sweet crudes to be bid up in 4Q19.

U.S. Bank Outlook 2019 Still Sunny, But The Good Times May Be Behind Us


- S&P Global Ratings expects U.S. banks to face continued market volatility in 2019 stemming from a slowdown in economic growth, policy uncertainty, rising rates, and monetary tightening.

- Although it is not our current base, we believe we are incrementally closer to a turn in the credit cycle in 2019. When the credit cycle does turn, bank profitability will come under pressure as imbalances brought on by years of excess liquidity and low rates will flow through banks' income statements and balance sheets.

- Key areas of concern in credit are commercial and industrial (C&I) -- particularly leveraged lending, commercial real estate (CRE), and pockets of consumer credit -- credit cards, auto, and personal loans.

- Separately, fee income could come under pressure as the economy slows and if market valuations decline. Bank revenues in areas like assets and wealth management may also decline because they are tied, in part, to market valuations. Fees for originating and selling mortgage loans could also drop.

- Nevertheless, U.S. bank balance sheets are sound, with higher capital and liquidity levels, and we believe rated banks are well prepared to withstand potentially weakening credit conditions.

- New regulation may result in lower capital and liquidity levels for some (mainly regional) banks. On the other hand, the stressed capital buffer (SCB) proposal could prompt some global systemically important banks (GSIBs) to continue to face higher capital requirements.

- Longer term, from a business standpoint, it will be important for bank management teams to remain vigilant to disruption from technologically sophisticated competitors (fintechs), as well as to the threat of cyberattacks.

- Under our base-case scenario, we expect bank ratings to remain largely stable through 2019. 83% of our operating company ratings currently have stable outlooks, 8% have positive outlooks, and 9% have negative outlooks.

Our Fundamental Forecast For U.S. Banks In 2019 Remains Slightly Positive

Current U.S. Bank Ratings Distribution

Current Bank Ratings Outlooks

Bank Profitability Trends

Loan Growth Trends

Flattening Yield Curves And Rising Deposit Costs Should Lead To Decelerating NIMs

Asset Quality Is Excellent But Likely Will Deteriorate Incrementally As Rates Rise

Aggregate Net Charge-Off Rates Remain Below Historical Levels

Investment-Grade Loans Moving To Speculative-Grade Could Pressure Banks' C&I Portfolios

Low Interest Rates Have Helped Keep Debt Service Low For Consumers, But Trends Could Be Less Benign As Rates Turn Higher

The Evolving Composition Of Consumer Debt

Postcrisis Credit Card Loan Growth Has Been Robust

Capital Levels Are Likely To Decline For Regional Banks But May Increase For Some GSIBs

All Eight U.S. GSIBs Are Above Their Required Regulatory Minimums

Bank's Funding Profiles Remain In Good Shape

Liquidity Looks Decent, But Regional Banks' Liquidity Could Decline Due To A Recent Regulatory Proposal

Global Structured Finance 2019 Securitization Energized With $1 T In Volume


U.S. - Buoyed by expected low unemployment and continued GDP growth, 2019 U.S. structured finance issuance is likely to remain in the same neighborhood as last year, with the anticipated growth in RMBS largely canceled out by the likely contraction in CLO volume from record levels. This is not factoring in the expected decline in CLO reset/refi volume, due to the dynamics of prevailing liability spreads.

EUROPE - On most measures, we expect aggregate European structured finance credit performance to be positive in 2019. That said, the default rate will likely remain somewhat elevated compared with the pre-2008 time frame, but likely lower than its 1% long-term average.

CHINA - Continued normalization of growth, reduced liquidity due to policy-driven credit adjustments, uncertainty from the trade tensions with the U.S., and the rate hike environment outside China may pose threat to the performance of some industries. That said, we believe securitization remains largely shielded by conservative asset selection and transactions' repayment structures.

JAPAN - Although we expect stable rating performance to continue in 2019, the Japanese economy faces headwinds, which may hurt the performance of the underlying loan portfolios of RMBS and ABS transactions.

AUSTRALIA - Housing credit growth in Australia has slowed as lending standards have progressively tightened. This has restricted access to credit for some borrowers and led to property price declines in major capital cities. As such, risks are more elevated than they were twelve months ago.

CANADA - As interest rates and housing prices increase in Canada, consumer debt affordability could worsen, possibly leading to deteriorating consumer credit performance, which may affect consumer receivable performance metrics.

LATIN AMERICA - Credit conditions remain challenging in Argentina and investor confidence in Mexico has weakened since the inauguration of Andres Manuel Lopez Obrador. Meanwhile, in Brazil, market participants have reacted positively to the election of Jair Bolsonaro, but they remain cautious given the macro scenario.

Jan. 07 2019 — The past year turned out to be quite active in the structured finance markets, with over $1 trillion equivalent issued across the globe, representing double-digit growth on a year-over-year basis. The U.S., China, Japan, Europe, and Canada all showed volume increases, while issuance in Australia and Latin America (LatAm) declined. With continued GDP growth and unemployment low, U.S. structured finance markets are forecast to perform well over the foreseeable future. Some potential factors that could affect the continued global recovery of structured finance include the renegotiation of existing trade agreements, Brexit uncertainty, rising interest rates, and any market volatility that affects liquidity. Despite the risk of such exogenous shocks, we believe that the structured finance markets are unlikely to be affected broadly over the near term. As such, we expect 2019 issuance volume to be in the same $1 trillion neighborhood, and possibly slightly higher than last year (see table 1).

Table 1 summarizes our issuance projections relative to the volumes of the past four years.

Table 1

We recap 2018 and discuss our 2019 outlooks for the various structured finance sectors (by region and product) below.


Auto loan ABS: higher vehicle prices and used vehicle demand could increase issuance

Despite light-vehicle sales remaining nearly stable at approximately 17.2 million units last year, auto loan asset-backed securities (ABS) issuance accelerated approximately 12% to $81.7 billion from $73.1 billion in 2017. The largest contributors to the growth were Santander Consumer USA ($3.1 billion increase); World Omni Financial Corp., which increased its offerings to five ($2.5 billion increase) from two in 2017; and VW Credit Inc., which returned to the market with two transactions totaling $2.3 billion after being absent for three years.

While S&P Global Ratings forecasts auto sales to decline slightly, to 16.8 million units this year, we are expecting auto loan ABS issuance to increase 5%, to approximately $86 billion. This is based on increased loan origination volume (inclusive of used vehicles), reflecting both elevated vehicle prices as consumers shift to larger and more expensive sets of wheels, and increased used vehicle demand as rising interest rates and fewer vehicle incentives price some consumers out of the new vehicle market. Further, we may see more subprime auto loan origination and securitization activity this year. Subprime loan originations, after declining in 2016 and 2017, changed course during the third quarter of 2018, increasing 10% year over year, according to the New York Fed Consumer Credit Panel. Higher interest rates may also entice some banks to return to the ABS markets.

Prime collateral should continue to perform well in 2019 due to a favorable economic outlook, including record low levels of unemployment. In addition, from the second half of 2016 through 2017, many lenders tightened their credit standards or improved the mix of loans in their securitizations. In many cases, this was a response to losses trending higher than expected. While record-high levels of off-lease vehicles could put downward pressure on recovery rates, we didn't see this last year when there was a record number of off-lease vehicles. Instead, it appears that rising borrowing costs, new vehicle price appreciation, and reduced new vehicle incentive activity are increasing demand for used vehicles, which, in turn, is providing secondary market price support. Prime recovery rates, which plummeted for the 2015 securitization vintage, have stabilized for 2016 and 2017, and are improving for the first quarter 2018 vintage, coming in at 50% through month nine compared to 47% for the 2015–2017 vintages at the same seasoning point. Cumulative net losses (CNLs) for S&P Global Ratings' prime auto loan static index (ALSI) are trending toward 0.80%, 1.0%, 1.1%, and 1.0% for the 2014, 2015, 2016, and 2017 vintages, respectively. While it's too early to project the first-quarter 2018 vintage's performance, barring an economic slowdown, it's on track to experience CNL of less than 1% (see chart 1 below).

Chart 1

We expect subprime auto loan collateral performance to remain generally stable in 2019 given the current economic outlook. Also, some lenders have tightened their credit standards and have eliminated their worst performing programs. Others have indicated to us that they have improved their dealer oversight and have eliminated dealers or instituted harsh penalties for those dealers that send them loan applications with misrepresentations. At the same time, we have observed losses becoming more back-loaded in this sector due to the lengthening of loan terms and the more liberal use of extensions and modifications by some companies. The CNLs in this segment are extremely issuer dependent, ranging from a low of approximately 9% for a couple of issuers to a high of approximately 30%-35% for certain deep subprime securitizers.

Our ratings outlook for the sector is generally positive, especially for auto loan ABS carrying investment-grade ratings (of 'BBB- (sf)' or higher). However, speculative grade classes, which are typically issued on subprime auto loan ABS, will be more vulnerable to downgrades. Last year we upgraded 335 classes and downgraded two. Both of the downgrades stemmed from one subprime auto transaction--Honor Automobile Trust Securitization (HATS) 2016-1, whose class C notes we downgraded to 'CC (sf)' from an original rating of 'BB- (sf)'.t Strong ratings performance has been due to favorable economic conditions, with many transactions performing better than we had originally expected, and the deleveraging nature of these transactions, which has helped to offset those cases where CNLs have been slightly higher than we expected.

Last year, however, there was a record level of issuance in the 'B (sf)' category, which serves as the first-loss tranche. To the extent that our expected CNLs prove to be too low, the economy weakens, or there are originator/servicer-specific issues, these classes could become vulnerable to downgrade and default. Currently, we have two subprime classes on CreditWatch negative: HATS 2016-1's class B notes, rated 'BBB (sf)', and Sierra Auto Receivables Securitization Trust (SARST) 2016-1's class C notes, rated 'BB (sf)'. In our view, the 2018 downgrades and the above-mentioned credit watch negative actions are linked to idiosyncratic originator/servicer issues rather than symptomatic of widespread issues in the subprime auto sector.

Auto lease ABS: issuance and performance hold steady into 2019

U.S. auto lease ABS volume experienced flat growth in 2018 at $15.9 billion, increasing less than 1% from 2017's $15.8 billion. A couple of captive finance issuers, BMW and Nissan, were not as active in the segment this past year; they issued only one deal each, when historically they've issued two. Offsetting the decline is a new entrant into this market: Tesla, with two ABS deals totaling $1.4 billion. For 2019, we expect new issuance ABS volume of approximately $18 billion (we expect BMW and Nissan will return to their normal issuance cycle), performance will be stable, and ratings will remain stable.

Collateral metrics in auto lease ABS should remain consistent. Auto leases are generally offered to upper credit-tier customers, as reflected in the high FICO scores. We expect credit losses will remain low.

Residual performance should remain positive due to a favorable economic outlook, expected lower used vehicle value declines compared to previous years, and automakers' higher focus on managing production and inventory levels. Off-lease passenger cars have experienced the greatest residual value declines, as consumers shifted preference to sport utility vehicles (SUVs). Relatively low average gas prices and the availability and affordability of fuel-efficient SUVs have helped to cement these vehicles in consumers' favor. The mix of leased vehicles today reflects a greater ratio of SUVs to cars (approximately 70-30 versus 50-50 previously). The supply of off-lease vehicles reflects similar trends. Given the significant residual exposure experienced by automakers and captive finance companies over the past years, some have tried to limit incentive spending. However, as new-vehicle sales decline (S&P Global Ratings forecasts a slight decline in light-vehicle sales in 2019) and vehicle prices increase, the level and use of incentive spending to promote sales will be an interesting trend to watch. Vehicle affordability will continue to be a key concern for consumers amid rising interest rates.

We anticipate our ratings in this asset class will remain stable. Since the recession, auto lease ABS have generally experienced strong performance, with each vintage showing cumulative residual gains. Our residual stresses of at least 26% and 13% for 'AAA' and 'BBB' ratings, respectively, are well above actual performance. We also apply additional stresses for excess concentrations related to vehicle and segment, and if residual maturities are not well distributed. In addition, the credit enhancement in these transactions grows due to deal deleverage, providing more credit support as the transaction seasons.

Credit card ABS/Personal loan/Mobile handset: as interest rates rise and the cost of bank deposits increases, securitization may pick up; Verizon forges ahead

Credit card ABS

For 2019, we expect to see $30 billion-$40 billion in U.S. credit card ABS new issuance volume. In 2018, total issuance dropped roughly 25% relative to 2017, to $36 billion from $47 billion, as widening spreads made securitization comparatively more expensive than bank deposits, and issuance volume did not keep pace with maturities. We expect new issuance volume in 2019 to remain opportunistic, driven by the refinancing of maturing notes, funding costs, investor appetite, and the desire to maintain diversified funding sources. As interest rates continue to rise and banks feel the effect of more expensive deposits, we believe the economic incentive to use securitization as an alternative funding source will heighten. At the same time, we believe the regulatory environment will continue to constrain funding and lending decisions, which will act to limit issuance volume. In terms of performance, we anticipate slightly weaker, though still strong, trust performance and stable ABS ratings.

As consumers continue to take on increasing debt loads--benefitting from marginal real wage growth, GDP growth, and a low unemployment rate--revolving consumer debt hit an all-time high in 2018 of close to $1.04 trillion. To date, however, there has not been a corresponding increase in account additions into securitization trusts, and the receivables tracked in our U.S. Bankcard Credit Card Quality Index (CCQI) declined by approximately $5 billion (roughly 2%) over 2018. Since 2012, receivables in the securitizations tracked in the CCQI have declined by approximately $86 billion (or 31%), driven by lower cost deposits and high payment rates. Those receivables that remain in trusts are highly seasoned prime accounts, with approximately two-thirds exhibiting FICO scores above 720 and less than 10% with FICO scores below 660, which we consider subprime. In addition to FICO scores and account seasoning, we also monitor credit lines and balances, and the portion of pools from obligors who make the minimum required payment compared with those who pay their full balance each month. We also consider the unemployment rate, household debt service levels, the overall level of household debt, bankruptcy filings, the volume and credit quality of revolving credit, and alternative credit and payment options in our analysis.

We continue to observe high payment rates in the trusts, which could contribute to a further decline in securitized receivables, and in 2019 we could see an uptick in additions (of nonprime or new loans) to trusts, which, in turn, could result in higher losses. We expect a gradual increase in bankcard loss rates over the next two years from the current lows of approximately 2.5%, to a normalized level of about 3%–4% in securitized trusts and 4%-5% for the industry as a whole.

Historically, retail card losses have been approximately 2% greater than losses for bankcards. This is driven by the lower utility of retail cards and a lower payment priority, along with typically newer accounts and lower credit-quality obligors, among other factors. As the retail sector tries to keep pace with new market dynamics, such as advances in digital commerce and the resulting brick-and-mortar store closures, we expect increased performance volatility in private-label credit card receivables, especially from trusts with less diversified merchants that offer discount programs. Current retail card losses average just over 5%. We expect this number to increase over the next two years to 6%–7%.

We anticipate that our ratings will remain stable, despite possibly weaker performance from new loans and nonprime origination. For bank and retail cards, our average base-case loss assumptions of 5.5% and 8.0%, respectively, and our benchmark annualized peak loss stresses for 'AAA' ratings of 33% and 37%, respectively, are well above actual performance. As such, we expect that even our lower-rated bond classes should be well protected from any weaker performance in 2019.

Personal loan ABS

ABS issuance backed by personal loans originated by branch-based and online marketplace issuers was stable year over year, at approximately $12 billion in securitized transactions in 2018. Roughly, two-thirds of this issuance was from marketplace platforms such as SoFi, which represented 20% of the total $12 billion issuance in 2018 (excluding any student loan deals), and one-third from brick-and-mortar lenders. Cumulative marketplace issuance has totaled approximately $25.6 billion since the industry's inception, while branch-based lending issuance has totaled approximately $24.4 billion since 2012. We expect stable-to-slight growth in 2019 issuance volume for both branch-based and marketplace platform lenders, for a total issuance of $10 billion-$15 billion.

As the market has matured and market participants gain more comfort with the asset class, investor demand--also driven by a search for higher yield--has led to new entrants securitizing for the first time in 2017 and 2018. We expect to see similar trends continue through 2019. However, marketplace lenders continue to face legal uncertainty concerning "true-lender" questions. To date, S&P Global Ratings has rated only a handful of marketplace lending securitizations for which we felt this legal risk was mitigated. We continue to monitor the legal developments in the space and maintain a measured approach.

We continue to observe marginal increases in both delinquencies and charge-offs in the personal loan space. Some of the deterioration is driven by a normalization of performance, but credit deterioration has also been driven by pool composition. As more lenders enter the space and are looking to grow, they may be competing to lend to potentially riskier borrowers. We continue to see a strong availability of credit and an increase in personal loan volumes to the lower credit-tier of borrowers as competition grows among lenders on both terms and funding speed. Although some issuers have tightened underwriting standards, we have not yet observed a significant improvement in loan performance for recent vintages.

As interest rates continue to rise through 2019, we expect most marketplace platforms to pass on these rate increases to borrowers, which will increase costs to the obligors and may have a negative impact on ability-to-pay metrics and loan performance. Over the next two years, we expect loss rates to continue to creep into the higher end of the 8%-10% range as we enter the late stages of the credit cycle. However, lenders are looking to manage delinquencies and losses with technological advances in risk mitigation tools and payment options for borrowers, and the centralization of core operational functions. In spite of increasing loss trends, we expect our ratings to remain stable as losses are offset by increasing credit enhancement owing to the deleveraging nature of the deal structures.

Mobile handset

To date, Verizon remains the only one of the four major U.S. wireless carriers to issue publicly-rated device payment plan agreement (DPPA)-backed ABS bonds. During 2018, Verizon completed two more DPPA transactions, bringing its total DPPA issuance to $9 billion across seven transactions since July 2016. ABS investors appear to have fully embraced this relatively short-term, stable-performing asset. Verizon's consistent loss performance across obligor tenure segments, supported by a growing body of historical static pool loss data, led us in September 2018 to upgrade all of the class B and C notes in Verizon's existing transactions. These upgrades included raising our rating on all of transactions' class B notes to 'AAA (sf)' from 'AA (sf)'.

Under our operational risk criteria developed specifically for wireless DPPA ABS, new entrants in 2019 will need to overcome several DPPA-related risks in order to achieve note ratings higher than the carrier's corporate rating (see "Global Framework For Assessing Operational Risks Specific To Wireless Device Payment Plan Agreements," published Dec. 6, 2017). Along with this operational risk component, the degree and sufficiency of historical loss data and upgrade program-type credit exposure may also present relevant asset-related risks.

Factoring in potential rating limitations that may result from the application of these operational risk criteria, we believe that Verizon will maintain its existing annual volume of DPPA securitization in 2019 at $2.0 billion-$3.0 billion, across two-to-three transactions. Should another major carrier decide to issue and successfully achieve ratings elevation, the amount of DPPA bonds issued could accordingly increase.

Student loan ABS: 2019 issuance to be marginally higher, as private student loan ABS portion should grow, while FFELP issuance will likely be near 2018 levels

For the first time in quite a while, annual student loan ABS issuance increased to approximately $18 billion in 2018. Navient's transactions accounted for nearly $7 billion, with four deals securitizing loans originated under the Federal Family Education Loan Program (FFELP) and five private student loan transactions primarily resulting from the acquisition of Earnest last year. Other large issuers this year were SOFI, with four private student loan deals for $3.1 billion, and Nelnet's five FFELP transactions for just under $3 billion. The top three issuers brought $13 billion to market in 2018. This year, the ABS market saw 19 private student loan deals and 13 FFELP loan backed offerings. Private student loan bond issuance for muni-type state authorities was also active, with nine additional deals closing for $1 billion.

Private student loan pools have maintained strong credit quality. The characteristics for the obligors in the refinance student loan pools have been consistent even though loan originations continue to grow. Lenders may not all be targeting the same obligor credit profile, but each lender has maintained credit discipline in their respective target areas. Loan performance for the refinance products has been very good, reflecting the strong economy and the stable employment rate. Prepayment rates continue to be in focus at this time. The less frequent in-school private student loan pools have also been consistent with the average FICO score and the percentage of co-signers in the pools. Loan originators for the in-school product have been growing originations at a moderate pace. We expect credit quality and ratings to remain stable in 2019 for the private student loan space.

Navient and Nelnet have been the two largest issuers of FFELP-backed bonds in the student loan market for many years, and we expect this to continue in 2019. Issuance levels have been about $8 billion for the past few years. Issuance in 2019 should be comparable, assuming both investor interest and issuer deal economics persist. We believe that the credit quality of FFELP student loan ABS will remain stable due to the U.S. government's guarantee on the underlying student loans. Legal final maturity concerns due to income-based repayment plans have been mitigated for new-issue transactions, with issuers moving legal final maturity dates far into the future. The impact of income-based repayment plans on older transactions differs depending on the issuer and servicer.

We requested comments on our proposed U.S. FFELP student loan ABS criteria on Nov. 12, 2018 (see "Request For Comment: U.S. FFELP Student Loan ABS: Methodology And Assumptions"). In the request for comment (RFC) article, we outlined a proposed analytical framework, including the use of a seven-year window to maturity and payment haircut percentages for analyzing liquidity risks associated with income-driven repayment plans in our surveillance process. We expect the proposed criteria revisions, if adopted, to adversely affect less than 5% of our outstanding FFELP student loan credit ratings. Once finalized, we anticipate stable FFELP ratings performance in 2019.

We expect issuance levels for 2019 to be marginally higher than in 2018. The private student loan ABS portion should grow, while FFELP issuance will likely be near 2018 levels. Combined issuance could reach $20 billion for the year.

Commercial ABS: sustained higher issuance volume expected, with repeat issuance from the base of new entrants from prior years

Our commercial ABS outlook for 2019 is for sustained higher issuance volume. For each of 2017 and 2018, equipment, fleet lease, and floorplan issuance totaled approximately $30 billion, and we expect similar volume in 2019. Equipment ABS volume increased somewhat during 2018 as new entrants, such as De Lage Landen (small ticket) and Daimler (truck loans), offset some declines in agricultural equipment. We expect sustained equipment ABS issuance volume into 2019, with the base of new entrants from prior years continuing to support volumes through repeat issuance.

Fleet lease issuance, while the smallest of the three segments, remains a consistent contributor, and we expect this to continue next year given the aging of fleets and the demand for replacement. Floorplan volume may dampen during 2019 in light of our outlook for slightly lower auto sales; however, the issuance in this segment tends to be more opportunistic than volume driven.

Commercial ABS encompasses a wide range of industry types, so credit drivers are diverse. While we acknowledge the diversity within the segment, we expect credit quality to remain generally stable, even with the impact of tariffs in certain industries. By market segment:

Agricultural equipment

The agricultural economy has suffered from a prolonged downturn since crop price declines began in 2014. While we expected 2018 to be a turning point, with slightly higher prices generating increased farm revenues, this did not pan out because tariffs caused volatility resulting in crop prices generally remaining depressed. Despite these challenges continuing into 2019, we don't expect much ratings volatility, as credit quality should remain stable. Farmers' balance sheets remain strong, due, in part, to strong farmland values. Also, while we've seen a decline in equipment values (affecting recovery rates for ABS), it has not been significant and has leveled off during 2018. We expect each of these factors to limit the extent of delinquencies and net loss increases on agricultural equipment loans in the coming year.


Truck loan performance is affected by conditions in the trucking industry, which are closely tied to overall economic activity that drives demand for freight services. We project continued increased freight demand during 2019, in line with our GDP growth expectations. Commercial truck values (recovery rates for ABS) are expected to remain strong during the first half of 2019 and then taper off somewhat in the second half as supply catches up with orders (given the longer lead time for tractor trailer truck manufacturing compared to auto manufacturing).

Construction equipment

Throughout 2018, construction companies (the obligors in construction equipment ABS) have felt the impact of both tariffs and immigration issues on profitability, with more expensive materials and labor. We expect these pressures to continue into 2019. In addition, continued increases in interest rates will likely affect demand because new homes and housing starts tend to be a driver of construction equipment loan performance. While construction equipment loan performance tends to be volatile, our stressed loss assumptions for equipment ABS we rate account for this, and most of the pools benefit from diversification, with construction equipment being mixed with other equipment types that have distinct credit drivers.

Small-ticket equipment

The commercial obligors on small ticket equipment loans benefited significantly from corporate tax reductions during 2018, although some of this was offset by input price volatility caused by tariffs. Our outlook is for continued stable performance of small ticket equipment loans for 2019, with slight increases in delinquencies above the record low levels that have persisted over the past five years.


The performance of non-diversified floorplan trusts is tied to the primary manufacturers that provide significant support, in the form of incentives, for example, to their dealers (the obligors on floorplan loans). This support is one of the driving factors behind the near zero loss performance typically exhibited by dealer floorplan ABS trusts. We predict slightly lower auto sales for 2019, but floorplan ABS will continue to benefit from manufacturer support through a combination of production cutbacks and incentives to align inventory levels with demand. Floorplan trusts can also be subject to event risk, as with the fraud allegations against Reagor-Dykes in 2018. However, diversification affords significant protections to investors in dealer floorplan ABS: Event risk with a single dealer would not represent a material percentage of the large overall receivable balance of a floorplan master trust and, consistent with our criteria, enhancement levels are sufficient to cover multiple obligor concentrations.

Non-traditional ABS: 2019 new issuance activity will be generally on par with that of 2018

We expect 2019 will continue to see strong non-traditional ABS issuance. We anticipate 2019 new issuance activity will be generally on par with that of 2018.


Container ABS saw 2018 issuance on par with 2017, as eight rated transactions came to market. Container performance has continued to slowly improve since the 2015-2016 downturn, with few defaults and gradually improving utilization and lease rates. However, as in 2017, some pools on our existing book of transactions were negatively affected by a reduction in total collateral due to asset dispositions. Continued consolidation in the shipping sector is generally viewed as credit-positive by container market participants, but has led to some increase in the credit concentration of securitized pools.

Aircraft leases

Securitization of aircraft leases remains an important source of financing for the aviation industry. In recent years, robust new issuance was spurred by growth in the commercial aviation industry, as well as demand from new ABS investors. New capital flowing into the aircraft leasing space has supported the formation of new leasing platforms, as well as increased competition among lessors. While the sector continues to benefit from an extended industry cycle, we remain focused on the ability of new leasing platforms to withstand an economic downturn and other industry trends that may put downward pressure on securitization performance.


The railcar ABS sector saw moderate issuance, reflecting both refinancing activity and financing of new purchases by financial investors under ongoing portfolio acquisition programs. In addition, one transaction was brought to market by a major manufacturer/servicer. Railcar collateral performance was stable, as defaults were low and utilization and lease rates modestly improved. While crude oil prices have fluctuated, North American production has remained fairly stable, contributing to steady utilization and lease rates for railcar assets. Amortization on the rated notes has generally been sufficient to outpace any collateral performance declines and support the ratings on our existing transactions. We expect similar issuance volumes in 2019.

Whole business

Following an active 2017, corporate securitizations continued to feature prominently on the non-traditional menu in 2018. S&P Global Ratings assigned ratings to nine whole business securitization transactions during the year (representing total new issuance of about $6.7 billion), many of which met strong investor demand. The activity included refinancings from repeat issuers, including Wendy's Funding LLC, Domino's Pizza LLC, Driven Brands Funding LLC, Hardee's Funding LLC, Applebee's Funding LLC/IHOP Funding LLC, Sonic Capital LLC, FOCUS Brands Funding LLC, and Taco Bell Funding LLC. The year's activity also included a non-restaurant transaction by new issuer Planet Fitness Master Issuer LLC. The issue was backed by fitness club royalties--a first for the corporate securitization sector. Same-store sales and system growth were generally stable for some of the larger corporate securitization operators, while some smaller concepts continued to see softer performance. The year saw consolidation among some corporate securitization restaurant issuers, as parent company Inspire Brands consolidated the Arby's, Buffalo Wild Wings, and Sonic brands, while FOCUS Brands acquired Jamba Juice. Given the robust issuance activity over the past two years, the pace of new issuance in 2019 is likely to moderate somewhat because there should be fewer deals that need to refinance during the year.

Small business

In the small business sector, interest among SBA 7(a) license holders to securitize loans remains strong. In 2018, two first-time issuers, Harvest Small Business Finance and First Western SBLC, accessed the capital markets, as well as repeat issuer Newtek Small Business Finance. Collateral performance among transactions rated by S&P Global Ratings was generally stable, and we expect to see new issuers come to market in 2019 as well.

Real estate-related transactions

In 2018, S&P Global Ratings also rated four real estate related transactions (representing total new issuance of about $2.0 billion). The year's activity included the ABS sector's first two data center lease-backed transactions by issuer Vantage Data Centers, triple-net issuer STORE Master Funding's first 'AAA' rated issue, and an issuance from repeat issuer Spirit Master Funding.

PACE transactions

In April 2018, we assigned 'AA' ratings to Ygrene's GoodGreen 2018-1 PACE (Property Assessed Clean Energy) transaction; this was the first transaction to receive S&P Global Ratings' credit ratings. PACE is a financing that enables property owners to finance renewable energy and energy efficient improvements and repay such amounts through an assessment or special tax on their property bill. PACE loan originations were down this year following the passage of California's "ability-to-pay" legislative requirements.

Timeshare; Timeshare issuance remained steady in 2018. Repeat issuers, including Orange Lake, Marriott, Wyndham, Vistana, Hilton, Bluegreen, and Diamond Resorts, accessed the capital markets, as did first-time issuer Accelerated Assets. Collateral performance was generally stable. Like many of its peers, including Marriott, Hilton, and Starwood, Wyndham has separated its hotel and timeshare business. The spinoff of Wyndham Hotels and Resorts Inc. from Wyndham Worldwide Corp. was completed in June 2018. We do not expect any impact on securitization performance.

CLO: moderate overall decline in volume expected

Following a record 2018, with roughly $130 billion in new collateralized loan obligation (CLO) issuance and some $160 billion in resets/refis, we expect a moderate overall decline in volume during 2019. Our projections for both gross new issuance in 2019 and resets/refis is $110 billion apiece ($220 billion total). The balance of resets and refis should change somewhat in 2019 from the roughly 80/20 split in 2018. The factors that will drive that mix, such as the prevailing liability spreads (current and at issuance for eligible CLOs), will change from the first half of the year to the second, making it tough to predict what the final outcome will be, although we suspect that the mix may be closer to 60/40.

Upgrades of CLO tranches continued to outpace downgrades in 2018 overall, but we continue to see the number of upgrades come down compared with the years before the advent of the CLO reset boom (see chart 2.)

The primary reason for this is that amortization is being delayed by the record number of resets. We upgraded just 13 classes in the third quarter of 2018, compared with five downgrades; in the fourth quarter, we upgraded six classes and downgraded 10. Upgrade counts averaged roughly 150 in 2016 and 50 in 2017. Subordinate classes are also showing a bit more downgrade risk, as the average CLO obligor credit mix has shifted more toward 'B' and 'B-' rated credits from 'BB-' and 'B+', and the recovery prospects for loans in broadly syndicated loan (BSL) CLOs continue to deteriorate (see charts 3 and 4).

Another concern for CLO collateral is documentation/loan structure erosion, which could further pressure recovery rates and exacerbate credit distress in a potential downturn. Items CLO investors are keeping an eye on include an increase in loan leverage, a decrease in loan debt cushions, the proportion of covenant-lite loans, and EBITDA addback issues. On the CLO document side, we think the pressure has eased somewhat from earlier in 2018, when CLO investors flexed their muscles and tried to add a number of equity-friendly provisions to indentures during the CLO creation process (see "Par Wars: The Investor Strikes Back," published May 2,2018, available at

We don't foresee much weakness within the investment-grade classes, which should continue to perform well, notwithstanding an idiosyncratic performance downgrade here or there (e.g., if a manager overweights a particularly distressed industry).

CMBS: flat issuance year over year expected, as competition for originations from a growing variety of capital sources continues

We expect $80 billion in U.S. private-label commercial mortgage-backed securities (CMBS) issuance in 2019, not including commercial real estate (CRE) CLOs, which is flat on a year-over-year basis. The single-borrower sector should continue to account for about half of transaction volume, flat relative to 2018 and up from roughly 40% in 2017 and 30% in 2016. Hotels are likely to remain a popular property type for the single-asset single-borrower transactions, accounting for about 40% of dollar volume in 2018.

Competition for originations from a growing variety of capital sources have resulted in somewhat subdued volume during 2018, which will likely continue in 2019, with most loans drawing from alternative funding sources. Outstanding CRE and multifamily loan volume is up nearly $1 trillion from the previous peak, to $4.2 trillion as of the third quarter of 2018, according to figures from the Federal Reserve. Meanwhile, the outstanding amount of CMBS is somewhat lower than in 2007–2008, though it has grown moderately over the past couple of years.

On the credit side, we see several risks to the status quo, which was characterized by stable underlying CRE performance and positive rating activity in CMBS over the past few years, as measured by an upgrade to downgrade ratio of 1.7 to 1.0 in 2018, and even more positive figures in 2016/2017 when the maturing volume was much higher (see table 2).

Table 2

By any measure, current CRE valuations are high. Generally solid CRE fundamentals, a supportive macroeconomic environment, and continued investment demand in a low-yield environment have kept pricing stable and elevated. Still, equity market volatility, trade wars, Brexit, the prospect of slowing economic growth, and rising interest rates are just a number of external factors that could lead to a decline in prices, and knock-on impacts to CMBS credit.

We believe our ratings are well positioned for this, based on the gap between appraised values and S&P Global Ratings' property values. This gap varies by property type, but was roughly 35% on average in 2018, and it stems from our haircuts to underwritten cash flow and our utilization of stressed cap rates (currently about 150 basis points above market values).

By property type, we are focusing on multiple areas. Retail, where e-commerce continues to force evolution of retailers' business models, has been growing as a percentage of conduit pools, especially in the third and fourth quarters of 2018 (see chart 5). 

Chart 5

In the suburban office space, we're paying close attention to single-tenant exposures. Office exposure has been steady quarter-over-quarter, but is down from elevated figures (roughly 40%) a year ago. For hotels, where exposure has been relatively steady at about 15% in conduits, occupancy is at a historical peak, but supply is gaining and revenue growth is slowing in some locations.

Another credit trend we've been watching is the high percentage of interest-only (IO) loans in collateral pools (see "IO! IO! How High Will Full-Term Go?," June 8, 2018). We have concluded that default rates for full- and partial-term IO loans were roughly 1.5x their amortizing counterparts over the 2000-2008 period, and that loss rates were relatively higher for partial-term IOs versus both full-term IOs and amortizing loans. While there were some mitigating factors (full-term IO loans have had lower beginning loan-to-value (LTV) ratios than amortizing loans in recent years, albeit with a narrowing gap, and have tended to be located in primary markets), the percentages of IO loans--and especially full-term IO loans--was up in 2018 (see chart 6). 

Chart 6

We believe that overall sector fundamentals remain stable, however, and expect rating activity to remain relatively stable in 2019 absent a considerable external shock.

RMBS: non-QM tally could double, increasing overall issuance

Non-agency residential mortgage-backed securities (RMBS) finished 2018 with roughly $85 billion in new issuance (on the lower end of our 2018 $80 billion–$100 billion forecast). This marks a gain of roughly 20% compared to 2017 and more than doubles the 2016 tally of $34 billion. Almost one-third of the 2018 tally was related to credit risk transfer (CRT) securitizations by Fannie Mae, Freddie Mac, and a few mortgage insurance (MI) companies. Prime jumbo/conforming, re-performing, and nonperforming securitizations accounted for approximately 20%, 15%, and 10%, respectively. But perhaps the greatest year-over-year growth was attributable to nonqualified mortgage (non-QM), for which issuance reached about $10 billion, doubling the 2017 tally. Other RMBS product types, including mortgage servicing rights, single-family rental, servicer advance, reverse mortgage, and trust collapse, accounted for the remaining 10%-15% of the total 2018 figure.

Although mortgage rates have increased and there has been heightened publicity about home affordability concerns, we are projecting non-agency RMBS volume for next year to grow to approximately $100 billion. The issuance share of subsectors in non-agency RMBS should be mostly similar to that of 2018, with the growth in issuance volume largely driven by non-QM, which we think could double from the 2018 tally (see chart 7).

Chart 7

Our view on issuance and subsector representation accounts for the following:

Residential mortgage originations (according to the Mortgage Bankers Association as of November 2018) should decline by only a small amount, to $1.630 trillion in 2019 from $1.636 trillion in 2018 (with growth in purchase volume and reduction in refinance volume).
We expect the increase in the conforming loan limit, along with home price appreciation, to result in a similar volume of CRT issuance in 2019, depending on MI CRT issuance. Furthermore, agency eligible loans could continue making their way into non-agency RMBS, bumping up prime jumbo/conforming issuance.
Non-QM securitization volume in 2018 was roughly 1% of annual residential mortgage originations, and we expect non-QM issuance to grow in 2019 given the low starting point and increase in purchase volume.

Turning to credit, U.S. RMBS has exhibited overall strong or improving performance, with declining delinquency levels and continued home-price gains helped by low unemployment rates. For legacy RMBS issued before 2009, upgrades outpaced downgrades for the year, and almost half of the rating actions were affirmations, while roughly one-third related to ratings being withdrawn. The post-2008 U.S. RMBS criteria, issued in 2018, was accompanied by more than half the ratings being affirmed and about twice as many upgrades as downgrades.

Our forecast relates to home-price changes as well as the low unemployment rate, which should continue to bode well for most U.S. RMBS performance in 2019. We are projecting the year-end 2019 30-year conventional mortgage rate to be 5.4%, the 2019 S&P Case-Shiller 20-City Home Price Index annual percentage change from December 2018 to be 4.1% (cooling off from the prior-year gain), and the 2019 unemployment rate to be 3.6%. Negative rating movements are expected to be more isolated to outstanding legacy RMBS that may be exposed to low loan counts and interest shortfall risks.

ABCP: increases to federal funds rate and expanding sponsor portfolios could lead to moderate issuance growth

For U.S. asset-backed commercial paper (ABCP) in 2019, we expect a slight increase in volume, stable-to-slightly deteriorating credit performance, and stable ratings.

We expect U.S. ABCP outstandings to increase to $250-$260 billion in 2019, a moderate growth from $247.8 billion in outstandings as of Dec. 26, 2018. We expect to see sponsors continue to expand existing portfolios. Additional increases to the federal funds rate in 2018-2019 could positively affect volume as core corporate borrowers return to the market.

The European Union's new securitisation regulation and revised risk weights for calculating capital requirements came into effect on Jan. 1, 2019. The regulation sets out the legislative framework for simple, transparent, and standardized (STS) securitizations, which includes strict criteria that sponsors must meet to attain favorable capital treatment along with onerous disclosure requirements. Based on our discussions with conduit sponsors, we believe it is unlikely that many ABCP issuances will be structured to qualify as STS. However, we believe sponsors will structure underlying transactions to be STS-compliant where possible to benefit from lower capital requirements on liquidity lines. Overall, we currently do not believe the new securitisation regulation will affect our rating analyses on ABCP issued by European conduits, which primarily look at the credit quality of the liquidity providers. In addition, some European sponsors have focused on transitioning their programs to fully supported structures in response to the legislation.

In 2018, auto loans and leases made up about 25% of the underlying assets that back the ABCP issuances, followed by commercial loans and trade receivables, at about 16% and 9%, respectively. While traditional asset types continued to dominate portfolios in 2018, there has been a decline in invested amount backed by autos, the most dominant asset type financed in conduits. We observe a rising trend in ABCP backed by newer and non-traditional assets, such as market place loans and servicer advances, which could potentially increase credit risk in the portfolios. When we analyze the risk arising from these pools, we consider that the conduits typically cover credit risks associated with these asset types and that the structures incorporate relatively short credit exposures. Generally, we view ABCP collateral performance to be in line with the ABS sector performance. We expect stable credit performance to continue for ABCP in 2019 given the current favorable economic outlook of low unemployment.

VRDOs: muni issuers converting direct bank loans into VRDOs could increase issuance

We expect the volume of variable-rate demand obligations (VRDOs), including jointly supported financial obligations, standby bond purchase agreements, and letters of credit, will reach about $10.0 billion-$10.5 billion in 2019, an increase from $9.7 billion in 2018. The increase will likely be driven by muni issuers that convert direct bank loans into VRDOs backed by letters of credit or standby bond purchase agreements. As of 2018, New York and California were the top two VRDO issuance states, and tax-secured, utility, and housing bonds constituted over 80% of our rated VRDO portfolio. Heightened VRDO issuance is also expected in a rising interest rate environment, as these instruments continue to be attractive financing products helping issuers manage interest expense.


We expect tender option bond (TOB) volume to reach about $12 billion in 2019. S&P Global Ratings currently maintains ratings on approximately 3,158 TOB trusts, which have a total par value of approximately $46 billion. This is a substantial increase compared to the total number of TOB issuances in 2017. In 2018, we rated approximately 1056 TOB issues, versus the 469 TOB issuances that we rated in 2017. The $13.68 billion total outstanding par amount in 2018 also represents a substantial increase from the $5.77 billion par amount of TOBs issued in 2017.

We believe that the increase in TOB volume is mainly attributable to the recent increases in interest rates and market volatility. Because of the variable-rate nature of a TOB structure, investors with a floating-rate certificate (floaters) can essentially demand more interest on their floaters; otherwise, they can put their floater back to the trust. TOBs are another way for investors (money market funds) to invest in bonds over the short term when they feel that there is market volatility with respect to other investments, such as stocks. The put feature enables investors in floaters to tender out of their positions and receive their par plus accrued interest. The upsurge in TOB issuance due to these key influencing factors will likely continue as interest rates continue to rise and market volatility continues.


Incomplete technical standards for new regulations may mean a pause in securitization issuance

Investor-placed European securitization issuance was up for a fifth consecutive year in 2018, jumping by nearly 30% to more than €100 billion. However, we expect that teething problems with the EU's new regulatory regime for securitizations could push volumes back below this level in 2019. European covered bond issuance was also strong over the past year. In 2019, an increase in scheduled covered bond redemptions and the approaching maturity of issuers' cheap central bank borrowings could support a further modest rise in volumes.

Much of the recent growth in European securitization issuance has been due to the CLO sector, where 2018 volumes were up 40% on the previous year. This increase was partly due to U.S. managers issuing debut transactions backed by European collateral, taking advantage of buoyant market conditions. Auto ABS issuance also bounced back strongly after a weak patch early in the previous year, with over €20 billion issued in 2018. Meanwhile, Dutch issuers increased their use of both RMBS and covered bonds, placing €20 billion of debt, up 20% compared with a year earlier. Finally, the CMBS sector has shown renewed signs of life, after being largely dormant for the past two years.

However, some of the 2018 volume growth may have been due to a front-loading effect, with issuance potentially set to stall in early 2019. Lingering uncertainties over a new regulatory regime for European securitizations could have incentivized some originators to bring transactions to market ahead of the January 1 effective date and lead to a pause in issuance in early 2019. In addition, as the European Central Bank (ECB) gradually tapered its net asset purchases throughout 2018, structured finance spreads widened. Some originators may therefore have brought planned issuance forward to take advantage of still-favorable market conditions before the ECB's net asset purchases stopped altogether at year-end.

Transactions must comply with the EU's new securitization regulation since the beginning of 2019. As well as introducing preferential treatment for so-called "simple, transparent, and standardized" (STS) transactions, the regulation also includes a revamp of rules regarding risk retention, investor due diligence, and disclosures, which will apply to all securitizations. Drafts of various technical standards that provide additional clarity on the new rules are at different stages of the approval process. However, significant elements of this guidance and the market infrastructure envisaged in the regulations are not yet complete, despite the new rules coming into effect on January 1. Given the uncertainty this creates and the threat of significant sanctions for noncompliance, many originators may be reluctant to come to market until there is greater clarity.

For the disclosures element in particular, it will likely take market participants some time to adapt their business processes and reporting systems to comply first with transitional arrangements and then ultimately with the final requirements. On November 30, the joint European Supervisory Authorities published a statement acknowledging these practical issues and saying that regulators would enforce the newly applicable legislation in a proportionate and risk-based manner, potentially taking into account disclosures that originators already make in other formats. On the same day, the European Commission asked regulators to consider certain revisions to the draft standards. However, it remains to be seen whether this will allay concerns sufficiently to prevent a pause in issuance. If not, some originators may substitute covered bond issuance to meet their secured funding needs, but others may look to alternatives outside the structured finance market while the new regulations bed down. In addition, the eventual treatment of U.K.-originated transactions post-Brexit remains unclear. As things stand, once the U.K. leaves the European Union (EU) these transactions will not be able to qualify for the STS label under the new rules, potentially reducing their appeal to some EU-based investors.

The impending maturity of central bank funding could be a boon to debt issuance

Over recent years, monetary policy has also significantly affected supply-and-demand dynamics in the European structured finance market, through central banks' asset purchases and provision of low-cost bank funding. Bank-originated European structured finance volumes have been depressed for several years given the availability of cheaper funding alternatives offered by the ECB and Bank of England. However, these central bank schemes have now been closed to new drawdowns for some time and the maturities for these borrowings are on the horizon. Provided central banks do not launch similar replacement schemes, bank issuers are increasingly likely to once again tap debt markets as they plan for the gradual run-off of this official sector term funding. Already in 2018, the bank-originated share of European securitization issuance (excluding CLOs) rose to more than 40% from a historical low of less than one-third in 2017.

Covered bond issuance, in particular, could benefit from the approaching maturity of central bank funding. Benchmark covered bond issuance in 2018 was up 10% on the previous year, despite a decline in the volume of redemptions. We expect covered bond redemptions to be somewhat higher in 2019--a positive for gross supply. Also, many covered bond issuers are now further advanced in addressing new regulatory requirements for their liability structures under the EU Bank Recovery and Resolution Directive. This may ease the recent downward pressure on covered bond volumes caused by issuers' enforced focus on other types of funding issuance. Another positive is that the European Commission's project to better harmonize the region's covered bond markets is nearing completion, lifting some uncertainty.

Our issuance figures here do not include the volume of CLO refinancings and resets, which accounted for about €20 billion of further activity in 2018. However, with CLO liability spreads now wider than in early 2018, collateral managers will likely have less incentive to refinance or reset transactions that exit their noncall periods in 2019, so this activity looks set to decline.

European structured finance performance likely to remain positive

On most measures, we expect aggregate European structured finance credit performance to be positive in 2019. That said, the default rate will likely remain somewhat elevated compared with the pre-2008 time frame, but likely lower than its 1% long-term average.

For most asset classes, the 12-month trailing average change in credit quality has been positive for at least two years, indicating aggregate upward ratings movements (see chart 8). Although the eurozone economy has shifted down a gear since early 2018, we still expect GDP growth of 1.6% in 2019, which should support structured finance collateral performance. Legacy CMBS transactions are now largely wrapped up, with most of the expected losses already crystallized. In the U.K., economic growth will likely be slower, even in our base case, with downside risk from potential Brexit-related disruption.

Chart 8

S&P Global Ratings' sovereign rating on Spain currently carries a positive outlook, which could be credit positive for securitization ratings that are constrained by Spanish country risk considerations. However, the reverse is true for Italian securitizations, where the sovereign outlook is currently negative.

The trend in the ratings mix of outstanding European structured finance securities may also give indications of upcoming credit performance. On this basis too, aggregate credit quality has generally been improving since mid-2015. Through 2018, the proportion (by rating count) of outstanding ratings in the 'CCC' category or lower continued to fall, to 4.7% at the end of September from 6.1% a year earlier. In addition, the proportion of 'AAA' ratings has been slowly rising and reached a seven-year high of 18.0% in September 2018, up from 17.2% a year earlier. That said, the 0.9% of ratings that remain in the 'CC' category relate to securities that are currently highly vulnerable to nonpayment and for which we expect a default to be a virtual certainty, even though it has not yet occurred. This implies that the default rate could remain elevated relative to the pre-crisis period through 2019, as some older-vintage transactions continue to underperform, despite the wider positive rating trend.

Finally, two recent proposals for changes to our rating methodologies could affect European structured finance ratings in 2019, if adopted. Proposed changes to our approach for rating securitization tranches higher than the related sovereign could lead to some rating increases where the sovereign is rated 'A+' or lower. Similarly, based on proposed changes to our assessment of counterparty risk, we may raise some ratings in approximately 10%-20% of European structured finance transactions by up to three notches, although the changes may also lead us to lower ratings on tranches in 5%-10% of transactions.


Macro challenges unlikely to significantly alter transaction performance

The many challenges China faced in 2018 may continue in the new year, but it is unlikely for them to affect securitization performance or issuance in a significant way. Macroeconomic trends, such as continued normalization of growth, reduced liquidity due to policy-driven credit adjustments, uncertainty from the trade tensions with the U.S., and the rate hike environment outside China, may pose a threat to the performance of some industries. We believe, however, that securitization remains largely shielded by conservative asset selection and transaction repayment structures.

Asset performance has been stable in Chinese securitization transactions in 2018, except for very limited stress cases of servicer transition, originator failures, and missed interest payments. Retail securitizations continued to demonstrate strong performance: The cumulated asset default rate in auto loan ABS vintages kept improving, and mortgage default rates in most RMBS transactions remained below 0.5%. The stable employment, rising household income, shorter loan tenors, and full-amortization nature of most loans support debt serviceability for these sectors.

We expect an approximate 10% increase in 2019 Chinese securitization issuance, with about U.S. $310 billion-equivalent new notes. Commercial banks' intention for balance sheet adjustment and nonbank issuers' funding needs are addressed by increasing investor acceptance of securitization notes, which will drive the issuance growth in 2019. The gradual saturation of eligible issuers, however, may prevent the high growth we saw in the past few years. Annual new issuance in the market reached Chinese renminbi (RMB) 2 trillion (U.S. $292 billion) as of the end of 2018, slightly exceeding our expectation (see chart 9).

Chart 9

Growth was mainly driven by strong issuance of RMBS and corporate receivables securitization, and robust demand for auto loan ABS. The regulations that intended to contain risks in cash loans drove down issuance from nonbank consumer finance companies and online lending institutions. With the strong issuance in RMBS, banks regained their position in securitization issuance in China, accounting for more than 55% of new offering. We expect the RMBS issuance trend to persist in 2019, and may see more auto loan ABS issuance due to subdued activities in 2018 (see table 3).

Table 3


Expect steady issuance growth

In 2019, we expect the issuance of Japanese structured finance transactions will be between $57 billion and $60 billion, 4%-9% higher than the level seen in 2018. We saw issuance growth of roughly 10% in 2018 and expect the upward trend to continue in 2019. RMBS and ABS are the main asset classes in Japan, making up about 95% of total issuance. Within the RMBS sector, the Japan Housing Finance Agency is by far the largest originator, accounting for more than one-third of overall issuance of Japanese structured finance in 2018. Within the ABS sector, auto ABS and other consumer ABS are the main sub-asset classes in Japan. We expect these trends to continue in 2019.

The rating performance of Japanese structured finance transactions was stable in 2018. Most surveillance actions affirmed existing ratings based on the stable performance of the underlying collateral pool, with a limited number of rating upgrades and downgrades. We expect the stable rating performance to persevere in 2019. However, the Japanese economy faces headwinds in 2019: The government plans to hike consumption tax in October and the U.S.-China trade dispute could exert downward pressure on businesses in Japan. These headwinds may hurt the performance of the underlying loan portfolios of RMBS and ABS transactions. But we expect any impact to be relatively limited, as we forecast major macroeconomic factors, such as GDP, the unemployment rate, foreign exchange rates, and policy rates, to stay near the levels seen in 2018 (see table 4).

Table 4

For a more detailed discussion, see "Japan Structured Finance 2019 Outlook: Securitizations Should Brush Off The Consumption Tax Hike," published Dec. 27, 2018, on RatingsDirect.


Issuance to be slightly up as number of bank issuers who did not come to market last year are likely to issue in 2019

Australian structured finance RMBS issuance, the major asset class in this region, was dominated by the nonbanks in 2018. Overall housing credit growth slowed to under 5% as regulatory limits on investor and interest-only lending across the authorized deposit institutions (ADI) sector continued to take effect. Nonbank originators have capitalized on these lending opportunities and grown at over twice the rate of ADIs. We expect that nonbanks will continue to capitalize on these lending opportunities in 2019, bolstering supply. Offshore investors searching for yield have increasingly been attracted to this asset class given its historically strong credit and ratings performance. Their continued interest in this sector will influence issuance and pricing levels in 2019. We expect 2019 issuance levels to be slightly up on 2018, as a number of bank issuers who did not come to market last year are likely to issue in 2019 based on their 18–24 month issuance patterns.

The Australian RMBS sector has continued to perform well, with arrears and losses low, LTV ratios generally modest, and seasoning levels generally high. Risks are more elevated than they were 12 months ago, though. Property prices in Australia have declined from their record highs. This is largely in response to the tightening in lending standards and macro-prudential measures implemented by regulators, which has restricted access to credit for some borrowers. Most loans underlying Australian RMBS transactions are relatively well insulated from moderate property price declines given their modest LTV ratios (weighted average LTV for the sector is 60%) and high seasoning (weighted average seasoning for the sector is 60 months). Lower-rated tranches of more recent transactions with less seasoning may be more exposed to ratings pressure in the next 12-18 months depending on the LTV profile of the respective transactions.

Outside of RMBS, ABS issuance has been fairly stable. ABS collateral performance has continued to be strong, as evidenced by low levels of arrears and losses. In recent months, the Australian government announced details of an AUD2.0 billion Australian Business Securitisation Fund. This fund will invest up to AUD2.0 billion in the securitization market, providing funding to smaller banks and nonbank lenders to on-lend to smaller businesses on more competitive terms. This initiative is to help address the difficulty that small businesses face in obtaining financing other than on a secured basis.


Solid economic fundamentals support securitization issuance and ratings stability

The Canadian structured finance market continues to improve. Transaction volumes increased by 19% to C$23.8 billion as of November 2018 from C$20.0 billion in full-year 2017, driven by credit card ABS and auto loan ABS. We believe the sector will continue its upward trajectory in 2019, led by credit card ABS and auto loan and lease ABS, with stable cross-border issuance. In the RMBS sector, our expectation is that volumes will continue to be low until challenges related to program establishment, investor acceptance, and cost-effective economics are overcome. On balance, we anticipate issuance volumes for 2019 to range from C$20 billion to C$22 billion, about a 12% decrease from 2018 issuance volumes (see chart 10).

Overall, high-quality collateral behind ABS, prudent consumer behavior (influenced by the full-recourse credit regime), and conservative lending practices will continue to balance the risks of consumer affordability and influence collateral performance. We expect Canadian term ABS transactions will continue to benefit from strong and stable performance in 2019. We believe our ratings on Canadian ABS will remain stable in 2019.

Chart 10

Ultimately, we believe the high-quality collateral behind ABS, originators and servicers with strong track records, prudent consumer behavior influenced by the full-recourse credit regime, and conservative lending practices will balance the risks of consumer affordability brought on by rising interest rates and housing prices. We expect that Canadian term ABS transactions will continue to benefit from strong and stable performance in 2019 and are thus forecasting for general ratings stability in Canadian structured finance bonds.

Credit card ABS

Year-to-date through November 2018, the C$15.4 billion of credit card ABS issuance was up 54% from C$10.0 billion in 2017, surpassing the 10-year issuance record. There was approximately C$4.5 billion in net new issuance above maturities in 2018. Less U.S. dollar-denominated issuance (54% compared with 66% in 2017) was transacted in 2018. Correspondingly, Canadian dollar-denominated issuance increased to 46% of total issuance from 34% in 2017. With US$6.5 billion (C$8.3 billion) of 2018 issuance volume being cross-border into the U.S. market, the major Canadian banks continue to access the broader and more diversified U.S. investor base (see chart 11). We expect 2019 credit card volume to range between roughly C$12 billion and C$14 billion, led by refinancing of maturing ABS (C$9 billion) and marginal growth in new issuance (C$3 billion), with U.S. dollar-denominated issuance remaining strong.

Chart 11

Canadian credit card receivables continue to demonstrate strong credit metrics such as high seasoning and credit quality. On average, approximately 83% of the receivables are of accounts aged at least five years, which leads to stable payments and performance. In addition, approximately 35% of Canadian credit card ABS receivables comprise accounts that can be classified as "super prime." The receivables are also geographically diverse, with province exposure consistent with the nation's population distribution.

Auto-related ABS (loan, lease, dealer floorplan, and farm equipment)

New vehicle sales as of September 2018 amounted to 1.6 million units and are expected to be slightly below the 2.1 million units seen in 2017. Nevertheless, auto related ABS issuance for the year as of November 2018 increased by 3% to C$6.9 billion, compared with C$6.8 billion in 2017. Auto loans increased by 23% from 2017 to C$5.0 billion and auto lease totaled C$1.4 billion--an increase of 7% over 2017. Approximately 65% of the C$5.0 billion auto loan ABS was cross-border into the U.S. market. Altogether, auto loan and lease ABS accounted for 95% of auto-related volumes.

The slowdown in auto sales is expected to continue in 2019, driven by weaker household wealth, higher prices for new vehicles, and increasing interest rates, all of which will negatively affect affordability. Overall, we do not expect any deterioration in the credit quality of collateral backing term ABS, and our expectation is that cumulative net losses will remain stable. For 2019, we expect Canadian auto ABS issuance volumes to remain unchanged from 2018 and in the range of C$6.5 billion and C$7.5 billion, with a 75%/25% split between term loan and lease ABS (see chart 12.)

Chart 12

Canadian mortgage products continued to develop

CMBS issuance volumes increased 18% to C$900 million from C$767 million in 2017. Canadian RMBS's C$0.5 billion issuance is reflective of a market transitioning from the federal government-guaranteed and insured mortgage-backed securities programs to private-label nonguaranteed and non-insured RMBS. Our expectation is that volumes will continue to be low until potential issuers overcome challenges related to program establishment and cost-effective economics. With respect to Canadian CMBS, the time-to-market and the competitive lending environment leave securitized commercial mortgages somewhat disadvantaged to traditional portfolio lending options. Thus, for 2019, we expect issuance will be about C$800 million, down 11% from 2018.

Latin America

Significant growth in Brazil and asset diversification driven likely by FIDCs

We observed a noticeable reduction in issuance volumes in 2018 (see chart 13), driven mainly by the difficult economic environment in Argentina and the general elections in Brazil and Mexico. Credit conditions remain challenging in Argentina and investor confidence in Mexico has weakened since the inauguration of Andres Manuel Lopez Obrador. Meanwhile, in Brazil, market participants have reacted positively to the election of Jair Bolsonaro, but they remain cautious given the macro scenario.

Chart 13

In 2019, we expect significant growth in Brazil and asset diversification, which will likely be driven by the issuance of traditional asset types via fundo de investimento em direitos creditórios (FIDCs; credit receivables funds). In addition, RMBS and covered bonds are a potential source of issuance for which we have observed market interest. We also believe that an important pick-up in new issuance will likely stem from the cross-border market, mainly driven by Argentina's public-private partnership program and infrastructure-related certificate repacks in other frontier markets. Moreover, funding needs from fintech companies across the region may also bring securitization opportunities.

We expect domestic issuance in Argentina and Mexico to remain flat. However, in Mexico, the new federal administration has stated that it intends to increase housing development significantly. Therefore, we believe that this may set the stage for increased issuance of RMBS, although it could take time to materialize. Meanwhile, we expect that equipment ABS transactions will continue to dominate new issuance over the next year.

In addition to domestic challenges, we expect external conditions to remain an obstacle for Latin America because of increasing interest rates in the U.S., rising trade tensions, and our expectation for slower GDP growth in developed economies, which could pressure trade flows and commodity prices. Nevertheless, we continue to expect positive GDP growth for Latin America next year.

Overall, we expect stable ratings across the LatAm region in 2019. Although collateral performance could deteriorate in Argentinian consumer transactions as a result of worsening conditions in the country's economy, we believe these deals still have sufficient credit enhancement to withstand higher delinquencies.