Higher Losses on the Horizon, S&P Stress Tests Predicts

  • William Hoffman
  • March 15, 2017

Predicting LossesPrime and subprime auto loss rates will rise above 1% and 6%, respectively, within the next six years, S&P Global predicts in its latest stress test report. However, if a recession hits — even a relatively mild one — those losses could be much greater.

The report — titled “How Will Auto ABS Pools Perform Through A Credit Cycle?” —  examines a range of stress scenarios, including one in which unemployment hits 15% for the first time since 1940 and an optimistic outlook that has unemployment declining to 3.5%. 

S&P’s baseline scenario, however, assumes unemployment is likely to stay around 4.5% while prime losses rise to 1.04% by 2022, up from the 0.71% rate they predict for this year. The ratings agency says subprime losses will rise to 6.77% in 2022, up from a predicted 5.66% in 2017.

However, S&P also looked at scenarios with a bleaker outlook for the economy.

If a mild recession, replicating the 1998-2003 period, were to hit the U.S. economy, unemployment could rise to 6%, while prime and subprime losses would increase to 1.66% and 9.61%, respectively, within six years.  

Interestingly, a more severe recession, like a repeat of the 2008 financial crisis, would increase prime losses only slightly more than in a less-severe recession, and result in a faster recovery, the data shows. One the other hand, subprime losses could quickly climb to 12% if there was another bubble burst. 

S&P Subprime Chart

The base case displays S&P’s predicted outcomes while scenario’s one, two, and three hypothesize increasingly worst economic outcomes for annualized net losses in the subprime space.

“Over the past six months, some lenders have tightened their credit standards,” the report states. “We view this positively; however, these corrective steps have only helped to offset lower recoveries. They have not led to a material or sustained improvement in losses. Nonetheless, they are a step in the right direction. At present, the competitive environment, prolonged economic recovery of nearly eight years, and tremendous availability in auto credit are contributing to higher losses than what we would otherwise see given current low unemployment levels.”

The stress tests also take the Manheim Used Vehicle Index into account in its projections, and in nearly every scenario S&P predicts used-car values will decrease. This is due in large part to the increase in off-lease volume entering the market — a record 3.6 million units in 2017 and 4 million in 2018.

During the 2008 financial crisis, the index fell as low as 100. In S&P’s baseline scenario it predicts values will fall to a score of 115 by 2022, and could drop to 104 if a mild recession were to hit.

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