Operating performance and credit metrics for U.S. captives are expected to continue to normalize following record profitability in 2021 and much of 2022, according to Fitch Ratings. Net interest margins will decline toward pre-pandemic levels given the impact of rising rates on funding costs, although a portion of that will be passed on to customers. Additionally, used car values are expected to moderate from record highs in 2023, yet remain well above pre-pandemic levels, as supply constraints ease and economic conditions hinder consumer demand.

Modest portfolio growth should continue in the near term, but could be hindered in early 2024 if economic conditions worsen in the U.S. and adversely affect customer demand for new and used vehicles and equipment. Fitch expects the U.S. economy to enter recession territory between 4Q 2023 and 1Q 2024, accompanied by rising unemployment and a drag on real wages due to high inflation

Higher credit losses experienced in 1Q 2023 were primarily driven by auto captives as average net charge-offs increased by 41 bps yoy, to 1.04 percent. Industrial captives experienced a 2 bps increase in credit losses yoy and continue to remain well below their pre-pandemic averages. Further deterioration in credit metrics is expected in the near term as the weakening macroeconomic backdrop adds pressure to consumers. Captives are expected to increase the allowance for credit losses for their retail portfolios in the near term as credit losses trend higher, which will be a headwind for profitability.

Captives remain the dominant issuers of debt relative to their manufacturing parents because of the capital-intensive nature of their businesses. Absent an improvement in capital markets conditions, captives may refinance near-term unsecured debt maturities with more cost-efficient secured debt, including with capacity under secured revolvers. While doing so would reduce funding flexibility, the average unsecured funding mix for rated captives will remain above the bottom of the ‘bbb’ category benchmark range of 35 percent based on remaining 2023 maturities.

Captive ratings are generally equalized with their parent company, as they are considered core due to strong operational/financial integration and their important roles in achieving the parent’s objectives.