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Auto Loan ABS COVID-19 Loss Adjustment Reassessed After Better-Than-Expected Performance

When the economy was grinding to a halt in late-March 2020 due to COVID-19, S&P Global Ratings was expecting a spike in unemployment levels that would lead to higher credit losses on auto loan asset-backed securities (ABS). Given that our rating approach incorporates a forward view of the economy, we increased our expected cumulative net loss proxies. While the unemployment rate did shoot up, reaching 14.8% in April 2020, and remained high throughout the year, the Coronavirus Aid, Relief, and Economic Security (CARES) Act (including enhanced unemployment pay of $600 a week) and payment extensions were surprisingly effective in offsetting workers' lost wages. As a result, losses remained below pre-pandemic levels. In December, with the economic recovery well under way, our economists revised their forecast for 2021 unemployment down to 6.4% from their June 2020 forecast of 7.2%. Given the improving employment outlook and better-than-expected ABS performance, we lowered our COVID-19-related loss adjustment in February of this year.

Since this February modification of our loss adjustment, we've observed the tremendous economic benefit resulting from the $900 billion federal rescue package this past December (paid stimulus checks of $600 per individual) and the $1.9 trillion American Recovery Plan (paid stimulus checks of $1,400 and continued federal enhanced unemployment pay) implemented in March 2021. These programs, along with a stronger vaccination uptake and faster reopening schedule than were anticipated at the end of last year, have turbo-charged the U.S. economic recovery, in our view (see "Economic Outlook U.S. Q3 2021: Sun, Sun, Sun, Here It Comes," published June 24, 2021). As a result, we expect GDP growth this year of 6.7% which is up from our December forecast of 4.2%, and average unemployment of 5.6%, down from 6.4% in December (see table 1). Our unemployment forecasts for 2022 and 2023 are 4.5% and 3.8%, respectively.

Table 1

S&P Global Ratings Forecasts (%)
Forecast as of: U.S. GDP 2021 U.S GDP 2022 U.S. GDP 2023 2021 avg unemployment rate 2022 avg unemployment rate 2023 average unemployment rate
Dec. 3, 2020 4.20 3.00 2.10 6.40 5.60 4.60
March 24, 2021 6.50 3.10 1.70 5.50 4.60 3.90
June 24, 2021 6.70 3.70 2.60 5.60 4.50 3.80

Stimulus Programs Have Created A Tailwind For Auto Loan ABS

The $2.8 trillion from the two stimulus packages and the improving employment picture have benefited auto ABS performance. Not only are auto ABS performing better than our higher expected loss levels adopted in late-March 2020 (see "The Potential Effects Of Covid-19 On U.S. Auto Loan ABS," published March 26, 2020), but losses for most deals rated before March of last year continue to trend well below our expectations when we originally rated them. The tailwinds associated with the various stimulus programs are reflected in the vintage cumulative gross loss performance for our prime and subprime auto loan static indexes (see charts 1 and 2). Had it not been for the pandemic, we would have expected the cumulative gross loss lines from the 2018 and more recent vintages to continue rising at approximately the same rate as the 2016 and 2017 vintages. However, there has been an abrupt slowdown in the rate at which losses are rising, primarily due to the COVID-19 stimulus.

Chart 1

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Chart 2

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In addition, delinquencies and annualized losses across outstanding auto loan ABS are at record low levels (see charts 3 and 4, and "U.S. Auto Loan ABS Tracker: April 2021 Performance," June 14, 2021). The stimulus programs have given consumers sustained cash to pay their monthly financial obligations, thereby reducing delinquencies, defaults, and the need for extensions. Extensions have fallen to pre-pandemic levels, if not lower (see chart 5). Further, more money in consumers' pocketbooks and the limited supply of autos is driving up the price of used vehicles, resulting in sky-high recovery rates, which are also contributing to the lower-than-normal losses.

Chart 3

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Chart 4

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Chart 5

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Reassessment Of Our COVID-19 Loss Adjustment

Taken together, the improved economic outlook and better-than-expected performance caused us to reassess the need for the COVID-19 loss adjustment. Consistent with our rating approach, to the extent issuer performance and pool characteristics warranted a relaxation or elimination of the COVID-19 adjustment, we reflected that in our expected loss levels. More specifically, we have analyzed the extent to which we believe an issuer or its pools may still be experiencing the impact of, or be particularly vulnerable to, consumer defaults resulting from COVID-19. For example, issuers that are still experiencing higher-than-historical extension levels or are securitizing pools with higher-than-normal deferral levels have been candidates for higher loss proxies than otherwise. To the extent that called collateral is being added to pools, we have examined the percentage of these loans that have been extended and the distribution by number of extensions. We believe loans receiving multiple deferrals are at greater risk of default than those that have received only one or two extensions.

Our reassessment at this time also considered the following:

  • The likelihood that the stimulus-induced performance benefit is not likely to be repeated; we have discounted the historically low loss levels when deriving our expected net losses for new transactions.
  • Our view that credit conditions are extremely favorable entering the third quarter (see "Credit Conditions North America Q3 2021: Looking Ahead, It’s Looking Up," June 29, 2021);
  • The unwinding of government stimulus and unemployment relief, which could negatively affect performance; we believe, however, that this will be offset by a strengthening economy as social restrictions continue to ease.
  • Our "improving" risk trend classification concerning a resurgence of the pandemic.
  • The expectation that supply and financing in the auto market will normalize toward the end of 2021.

Record recoveries

The derivation of our expected loss levels does not assume that today's record recovery rates will continue. We believe this is an anomalous occurrence due to a strange confluence of factors that is not likely to persist into next year. We continue to use issuer-specific historical average recovery rates in determining our expected cumulative net loss proxies.

The impact on credit enhancement levels

Given that our initial COVID-19 loss adjustment in March 2020 generally resulted in higher required credit enhancement levels at the 'BBB' and lower rating categories, we've reduced our required credit enhancement at those categories to the extent we reduced or eliminated our loss adjustment for an issuer or pool. Barring idiosyncratic changes in an issuer's pools, our required credit enhancement levels could return to 2019 pre-pandemic levels.

Why only the 'BBB' and lower rating categories are likely to be affected 

When the COVID crisis hit, we believed that the CARES Act and COVID-19-containment measures would prevent the economy from suffering a recession that would be as long and severe as the Great Financial Crisis. As such, our view was that only our 'BBB' and lower stress levels needed to be adjusted upward. As a result, the higher loss proxies generally resulted in higher required credit enhancement levels at the 'BBB' and lower rating categories. Our required credit enhancement levels at the 'A' and higher ratings were generally unchanged, except to the extent we observed significant changes in an issuers' performance before the loss-dampening effect of the COVID-19 stimulus/relief programs or material differences in their pool compositions.

A Word Of Caution

Performance metrics are at or near their all-time best levels, and delinquencies and losses will eventually normalize. Once stimulus checks and enhanced unemployment pay are spent, lenders relax credit standards to pre-pandemic norms, and recovery rates revert to historical levels, delinquencies and losses will rise. For this reason, our collateral performance outlook for subprime remains "somewhat weaker" (revised from "weaker," which was our view a year ago). The "somewhat weaker" assessment is in place to prepare the market for subprime auto's reversion to high losses (relative to where they are today). Given April's loss level of 1.47% (see chart 3 above), losses would need quadruple before they return to April 2019's pre-pandemic level of 6.60%.

Related Research

This report does not constitute a rating action.

Primary Credit Analyst:Amy S Martin, New York + 1 (212) 438 2538;
amy.martin@spglobal.com
Secondary Contact:Frank J Trick, New York + 1 (212) 438 1108;
frank.trick@spglobal.com

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