Fitch: External Factors Biggest Threat in 2014
December 4, 2013
Credit performance remained strong across most U.S. structured finance sectors in 2013 and the outlook for 2014 calls for more of the same. High credit quality collateral is again expected to underpin solid performance metrics and ratings stability for new issues across the core structured finance sectors – ABS, CMBS, CLOs and RMBS. These better optics, however, still need to be viewed in the context of legacy RMBS, CMBS, and CDO transactions, which account for the vast majority of negative Fitch Rating’s rating outlooks.
Structured finance rode the strong credit and performance and a favorable funding environment to issuance gains again in 2013. CMBS and CLO issuance reached post-crisis highs while ABS maintained a consistent pace. RMBS experienced modest growth despite constraining market and policy factors. Fitch expects the pace of structured finance issuance growth overall to moderate in 2014 given a number of external factors on the regulatory, policy and political fronts.
Consistent with recent years, regulatory overhang will pose a challenge in 2014 and beyond. Regulators have made progress on some outstanding issues stemming from legislation passed in the wake of the financial crisis, notably risk retention, Basel III and regulatory capital and liquidity issues. Fitch expects resolution on some fronts in 2014 with implementation likely in later years. While resolution could remove uncertainty, it could also act as a catalyst and pull forth issuance for certain sectors.
Fed tapering and a higher rate environment will be felt across all sectors, albeit to varying degrees. The longer term impact of a higher rate environment is expected to be most pronounced on CMBS, where refinancing needs could pressure existing transactions.
Repeated budget and debt limit standoffs have not directly impacted the performance or ratings of most sectors nor are they expected to. While any broader macroeconomic declines triggered by crisis-to-crisis governing could create some performance drags, rating actions are expected to be limited with the exception of FFELP-backed student loan ABS.
ABS Maintains Consistency
Collateral credit quality and performance measures are expected to remain strong and transaction structures robust throughout 2014. The rating outlook is stable to positive for most sectors, except for student loans where Fitch’s universe of ‘AAA’ rated FFELP backed ABS remain on Rating Watch Negative pending resolution of the U.S. sovereign rating.
Fitch’s outlook for prime auto ABS asset performance in 2014 is stable, even as losses are expected to increase, driven by rising loss frequency and severity. Fitch expects annualized net losses to range between 0.50%-1% in 2014 (similar to 2005-2006) and up from approximately 0.40% through the third quarter this year.
The performance of securitized credit card receivables has consistently exceeded expectations since the recession. Delinquencies and chargeoffs remain at or near historic lows and monthly payment rates are at record highs. Fitch believes that this exceptional collateral performance will persist into 2014, before receding moderately toward year end.
Student loan performance remains highly correlated with the economic environment when students enter repayment. While the collateral performance will continue to reflect the macroeconomic environment, FFELP student loan credit quality will mostly reflect the reinsurance provided by the U.S. Department of Education. Fitch’s outlook for private student ABS is negative for legacy and stable for post–crisis transactions. Performance remains under pressure as unemployment is expected to remain elevated but significant increases in defaults are not anticipated.
CMBS to Stay the Course
Fitch expects the positive momentum for U.S. CMBS loans seen since 2010 and past rating actions taken to provide ratings stability in 2014, especially for investment-grade CMBS. Fitch’s 2014 outlook for U.S. CMBS is stable. Macroeconomic factors will provide the key risk.
Underwriting will be of continued focus in 2014. All of Fitch’s metrics, bar debt service coverage ratio (DSCR), worsened in 2013. DSCR improved due to the decline in interest rates and the increase in interest only (IO) loans. DSCR will worsen in 2014 as interest rates tick up. Of particular note was the substantial increase in full or partial IO loans in 2013; they comprised 49% of the pool on average through the end of September compared to 33% in 2012. If DSCR starts to decline and LTV continues to rise, the uptick in credit enhancement will be more substantial all other factors remaining constant.
Property market fundamentals continue to improve, a trend that started in 2010. Continued economic recovery and a lack of new construction are the main contributors. Macroeconomic factors continue to provide the key risk to positive performance.