NEW YORK — Overall, DBRS indicated that auto asset-backed securities will likely hold up well throughout the year; however, the company does caution that it is closely watching the condition of the Detroit 3.

"The auto ABS market will be the most vulnerable to downside risk in 2009 due to the fragile financial condition of the Detroit 3," explained Christopher O'Connell, senior vice president of U.S. Structured Finance for DBRS.

"Although we believe existing auto ABS will hold up well in the face of a predictably weak economy and depressed used-vehicle prices, the sector faces dramatic changes and potentially severe performance declines in select trusts in the event of a continuing slide in new-vehicle sales or if any of the Detroit 3 domestic auto manufacturers fail," he continued.

"All auto ABS sectors are vulnerable, but wholesale auto ABS could be the most severely affected due to the trusts' reliance on vehicle sales to repay wholesale loans, dealership liquidity and manufacturer support in the form of purchase incentives to promote vehicle sales," O'Connell added.

Clearly, the auto industry has already been feeling the impacts of the economy on the issuance of auto ABS and O'Connell indicated that this trend will likely continue.

"The health of the domestic auto industry will be the most critical determining factor for ABS transaction performance and new issuance. The timing of the recovery of spreads in the public ABS markets and the ability of issuers to use strategies related to TALF and other federal programs will also affect new ABS supply," he wrote in a recent DBRS report.

Some of the biggest factors impacting ABS performance will be rising unemployment rates and the downward pressure on used-vehicle values, O'Connell highlighted.

"We expect these factors to drive an increase in the cumulative net losses by 20 percent to 30 percent and to push the levels of the historical delinquency cycle for auto ABS modestly higher," he explained. "Auto loan and lease ABS deals with older vintages are at greater risk of performance deterioration due to weaker obligor profiles, potentially leading to increased default frequencies and weak used-vehicle values, which could drive down recoveries.

"We believe newer vintages benefiting from stronger collateral and higher credit enhancement levels, reflecting more conservative assumptions, will weather the economic downturn comparatively better," he continued. "In all cases, subprime collateral will perform markedly worse than prime collateral due to the exponentially higher sensitivity of the obligor base to the weak economy in spite of higher yields on underlying loans and higher levels of enhancement."

As the economy took a hit in 2008, O'Connell indicated that supplies of used vehicles grew and residual values dropped. Also, incentives offered by dealers and automakers placed more pressure on used-vehicle pricing as well. DBRS expects these trends to continue "well into" 2009.

Talking a bit more about the risk of the Detroit 3, O'Connell said, "The auto ABS sector faces potentially seismic effects from a failure of any of the Detroit 3. In the event government assistance is successful in keeping these companies afloat and in a state of improvement, the companies will continue to produce vehicles and consumers will purchase them, albeit at a slower pace than in recent years.

"This positive outcome can restore consumer confidence in the companies themselves, lead to the origination of new loans and help stabilize used-vehicle prices," he added. "However, should the domestic manufacturers fail to turn around their companies, a grim fate awaits the market. Dealerships will close, new-vehicle sales will continue to decline and used-vehicle values will suffer as prospective buyers shun models related to the damaged manufacturers."

Additionally, he said if the financial condition of any of the automakers continues to slide, the prospect of servicing quality also takes a hit. This could have an impact of trust performance, which can be closely tied with servicer quality.

"While we believe it would take a catastrophic event, nothing short of bankruptcy of one of the manufacturers or finance companies, to severely affect servicing, the current fragile state of the industry warrants heightened consideration of servicing quality when assessing auto ABS in 2009," O'Connell stated.

Looking forward, DBRS forecasts the majority of ABS issuance this year will be from prime originations.

"We believe the TALF offers an excellent opportunity for more auto ABS to flow as a result of the prospect of attractively tighter spreads for issuers with limited financing options (i.e., the Detroit 3), and an opportunity for investors to buy higher-quality ABS," O'Connell related.

"The volume of this issuance will still be constrained, however, by low levels of vehicle sales. Therefore, we expect issuance in 2009 to achieve $30 to $40 billion," he concluded.