OREANDA-NEWS. November 24, 2015. If vehicle incentives continue their rise, they are likely to depress the value of used vehicles and contribute to higher loss severity and, ultimately, push up auto loan and lease ABS loss rates, Fitch Ratings says. The average incentive per vehicle has risen gradually this year and recently rose above \\$3,000 per vehicle in recent weeks.

Incentive levels rose to over 9% of the manufacturer suggested retail sales price in October, the highest level in over four years. If incentives rise even further, manufacturers are artificially driving sales, which can contribute to higher loss severity and losses in auto ABS.

If consumer demand slows next year and new vehicle sales decline, we expect manufacturers to ratchet up incentives to support sales, especially if vehicle inventories rise. This may impact used vehicle values negatively and pressure auto ABS loss rates.

Incentive levels have also been driven by weakness in demand and sales for smaller vehicle segments, including midsize and compact cars. These segments have recorded lower sales, while larger trucks and SUV sales have risen, buoyed by low gas prices and the introduction of fresh models like the new Ford F-150. This can negatively impact loss severity on auto ABS transactions, particularly pools with large concentrations of smaller vehicles.

However, one important mitigant to this risk is that current vehicle inventory levels are low. The average days vehicle supply was 69 days through Nov. 1, up from 60 days a month earlier, and have been hovering within range of the optimal 60 days target level for the industry throughout the year.

Fitch's prediction for auto sales in 2016 is 17.0-17.5 million units, flat to down over 2015. Current sales are tracking at an annualized pace of 18.2 million units through October.

According to Fitch's recently published "Automotive Handbook," incentives have risen due to higher transaction prices, resulting in a net increase in average transaction prices. Higher incentives have supported increased new vehicle sales in 2015, along with low interest rates and available financing.

Some seasonality in auto sales exists. As we enter the last six weeks of the year, manufacturers actively drive sales volumes and try to close the year out on a "sales high" to hit annual targets, clear lots of older 2015 models and drive market share figures. Ford Motor Company recently rolled out their "Friends and Neighbors" incentive program, while General Motors introduced the "Black Friday All Month Long" program. Both companies' incentive programs look to clear lots of older 2015 models to make room for newly introduced 2016 models.