OREANDA-NEWS. US auto lease ABS residual performance is still producing gains overall through mid-summer despite rising used vehicle supplies, Fitch Ratings says. However, further increases in vehicle supply in second-half 2016 and into 2017 could lead to pressure on residual values (RV).

Fitch's quarterly RV ABS index slowly declined over the past year. The index recorded a RV gain of 2.51% as of second-quarter 2016, down from 4.79% in second-quarter 2015 and 8.39% at second-quarter 2014. The average yearly gain in 2014 was 5.75%, which then slowed to 3.97% in 2015, and averaged 2.10% for the first half of 2016. The peak RV gain was 29.21% observed in first-quarter 2011. Fitch's outlook for auto lease ABS asset performance remains stable for the second half of 2016. This is supported by continual growing credit enhancement levels resulting in healthy levels of loss protection.

The persistent RV gains, albeit at a lower level, are partially due to the conservative establishment of securitized residuals in US auto lease transactions. Securitized residuals in US. auto lease ABS are often defined as the lesser of residual value established by the servicer at lease inception, Automotive Lease Guide's (ALG) value at inception, or ALG's mark-to-market value at the time of the transaction's closing. By securitizing the lowest of these and comparing that value to lease-end sales prices in determining an RV loss or gain, there is built-in RV loss protection.

Fitch expects the pace of upgrades to subordinate notes to continue for auto lease ABS in the second half of 2016. Upgrades are driven in large part to delevering transaction structures and growing credit enhancement levels. Further, Fitch's base case or 'BBsf' RV loss proxy is conservatively determined by isolating only the RV losses an issuer observed during the worst 12-18 month period, typically during the weakest 2008-2009 period.

Additional haircuts are employed as rating categories increase. This usually amounts to roughly 28%-32% in loss protection as a percentage of returned residuals for 'AAAsf' ratings, providing ample support. Even if RVs continue to decline throughout the remainder of 2016 and into early 2017, loss levels would have to be magnified above those levels to have an impact on outstanding transactions.

Used vehicle volumes entering the secondary market increased significantly due to strong lease originations in recent years. This led to higher supply of off-lease vehicles and trade-in volumes. Higher fleet and rental volumes entering the secondary market have also pressured residual performance.

Fitch's auto lease RV ABS index also tracks the amount of lease maturities and return volumes. The index recorded nearly $6.9 billion in returns (securitized RV amount) in 2015, up from $5.8 billion in 2014. In the first half of 2016, the index posted $3.7 billion in return vehicles, with $4.7 billion more expected in the second half, totaling over $8.4 billion. This is a 22% jump in returns this year versus 2015.

The used vehicle market saw a shift in consumer preferences in recent years. With sustained low gas prices and increased fuel efficiency, used vehicle prices for trucks, SUVs/CUVs and vans continue to outperform smaller cars. The full-line category is also outperforming luxury.

Luxury issuers account for approximately a third of residual returns in Fitch's Index and have averaged 0.45% in residual losses in the first half of 2016 compared with 2.95% in residual gains for full line.

Fitch's auto lease RV index tracks the performance of 39 US outstanding auto lease transactions totaling $28.4 billion of collateral as of June 2016, issued from 12 auto lease ABS platforms with data dating back to January 2007.