NEW YORK — Fitch Ratings contends modest year-over-year
deterioration in loss and delinquency rates produced by the largest U.S. auto
lenders signals an inflection point in auto loan asset quality.

Analysts said in their special quarterly report "U.S. Auto
Asset Quality Review," that they "expect asset quality trends to normalize
later this year and into 2014 as underwriting standards continue to ease."

Fitch explained the average U.S. vehicle loan/lease net loss
rate for issuers covered in its report came in at 0.68 percent during the
second quarter, down 26 basis points from the prior quarter. Analyst indicated
the trend reflected "the seasonally favorable payment trends typically
experienced in the second quarter of each year due to tax refunds."

However, Fitch noticed average net loss rate and average
30-day delinquencies increased year-over-year, by 17 and 45 basis points,
respectively. Analysts reiterated the trends are "signaling that credit
performance has reached an inflection point with future loss rates expected to
increase and revert to more normalized levels."

To compile its analysis, Fitch reviewed the quarterly
performances of:

—Ally Financial
—Toyota Motor Credit
—Ford Motor Credit
—JPMorgan Chase
—Wells Fargo
—Capital One
—GM Financial
—Huntington

"Lenders seem to be more willing to relax underwriting
standards against a backdrop of positive economic factors such as lower
unemployment, higher housing prices and higher consumer confidence," Fitch
analysts said.

"The Federal Reserve's April senior loan officer survey
continued to highlight easing in credit standards for auto loans, mainly
reflecting increased loan maturities and reduced loan pricing," they continued.
"However, Fitch Ratings does not believe that meaningful deterioration is
imminent as loss and delinquency rates still remain low by historical
standards."

Fitch insisted strong demand for new and used cars driven by
the ongoing economic recovery and rising consumer confidence in the U.S.
combined with cheaper funding continued to fuel loan origination volumes.

Analysts pointed out U.S new-vehicle sales climbed 9.0
percent to 1.43 million units in June, with annualized light-vehicle sales
hitting a 67-month high of 15.9 million units.

"A relatively positive economic outlook should result in a
healthy level of loan volume for the remainder of 2013," Fitch said.

Rising Rates Could Pressure Margins

Fitch insisted the recent spike in long-term interest rates
caused by the Fed's tapering comments resulted in slight spread widening in ABS
transactions.

"So far, the increase in interest rates has not materially
impacted issuers' net margins. However, future interest rate shocks could
pressure net margins, in the medium term, until issuers pass on the increased
cost of funding to consumers," analysts said.

"Still, given the short-term nature of the auto
loans/leases, lenders should be able to pass on increased costs to consumers as
evidenced by their long-term track record of operating profitably in various
interest rate cycles," they continued.

Positive Economic Indicators Support Credit Performance

Fitch reiterated that loss frequency in the consumer auto
finance space is generally tied to macroeconomic indicators, such as
unemployment and consumer debt levels.

The firm mentioned the job market conditions continues to
improve with employers adding an average of 200,000 jobs a month through the
first seven months of this year, up from an average of 183,000 a year ago.

Furthermore, the unemployment rate declined to 7.4 percent
in July from 7.6 percent in the previous two months and down from 8.2 percent a
year earlier. Short-term unemployment indicators such as unemployment insurance
weekly claims — which Fitch thinks are more correlated to auto loan credit
performance — fell to 344,000 on June 29, down 8.5 percent year-over-year.

Moreover, analysts pointed out the weekly insured
unemployment rate (seasonally adjusted) improved to 2.3 percent in the second
quarter from 2.6 percent in the year-ago period.

According to the Federal Reserve, seasonally adjusted
nonrevolving credit, which includes auto and student loans, increased to $1.98
trillion, up an annualized rate of 7.9 percent sequentially.

"The growth is consistent with the level of new vehicle
sales. Moreover, healthy growth trends in nonrevolving credit should, to some
extent, support prices of used vehicles," Fitch said.

Credit Terms Continue to Ease

The Fed's April senior loan officer survey reported that
banks are continuing to loosen application standards for individuals seeking
auto financing.

Survey respondents reporting eased credit terms stated that
most changes were occurring in loan pricing, with 25.8 percent of banks noting auto
loan spreads over the bank's cost of funds narrowed over the last three months
(down from 27.8 percent reported in prior quarter), and loan maturities, with
13.8 percent of the banks noting increasing maximum maturities on loans (up
from 13.1 percent reported in the prior quarter).

"A modest portion of lenders also indicated that easing
occurred in credit scores and down payment requirements," Fitch said.

"Aggressive pricing on loans suggests issuers are seeking
more ways to increase application volume and may not be fully pricing the risk
in the underlying loans," analysts continued. "A longer loan term implies a
slower repayment of principal, which, combined with falling residual values,
may exacerbate losses in case of repossession.

"That said, Fitch believes credit terms were materially
tightened during the credit crisis, and the current easing may, in part,
reflect a return to more normalized lending standards rather than aggressive
lending tactics," they went on to say.

Used-Vehicle Values Moderate

Fitch recapped that the Mannheim Used Vehicle Value Index
declined to 119.7 at the end of the second quarter, falling below the 120 level
for the first time since the third quarter of 2010, but remained "very high"
compared to the credit crisis level low of 98.0 hit in the fourth quarter of
2008.

"Fitch expects normalization in used car values to continue
but does not expect values to dramatically weaken as lower repossessions, more
aligned manufacturer production with new vehicle demand and improved quality of
domestic auto vehicles should offset some of the supply pressures keeping used
car values healthy and above crisis level lows," analysts said.

Fitch explained volatility in used-vehicle values is driven
by various factors including supply, make and model.

"Increased supply not matched by increased demand reduces
used-car pricing, which negatively impacts recovery values for lenders selling
repossessed cars or lease returns in auctions or wholesale markets," analysts
said. "Current delinquency rates, which are near historical lows, have led to
less repossession activity, reducing supply of used cars to some extent."

Fitch then acknowledged the impact of rising off-lease
volumes — which had dropped precipitously in the 2008—2009 financial crisis as
lenders pulled back on leasing due to lack of demand and unavailability of
financing — have soared since 2011 due to healthy consumer demand and increased
liquidity in funding markets.

"As a result, increasing lease maturities are expected to
hit the secondary market in the coming years, particularly in 2014, increasing
supply in wholesale markets. Lease residuals are also impacted by the make,
model and manufacturers' brand perception," analysts said.

"Historically, the Japanese car manufacturers enjoyed
relatively higher residual values than their domestic counterparts due to their
higher quality standards. However, in recent years all three domestic
manufacturers have introduced newer, more fuel-efficient lineups with remarkable
improvement in quality, resulting in stronger resale values and in some cases
closing the residual value gap with their Japanese counterparts," they
continued.

"In all, lower repossessions, more aligned manufacturer
production with new vehicle demand and improved quality of domestic auto
vehicles should offset increased lease return volume, keeping used car values
healthy and above crisis-level lows," Fitch went on to say.

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