U.S. tariffs on Mexican imports create trade risks that could affect Mexico’s equipment leasing sector and equipment lease performance, according to Fitch Ratings.
Fitch expects equipment asset backed securities (ABS) ratings to remain stable, given robust transaction credit protections such as default and liquidity triggers that preserve credit enhancement. Well-established originators with proven robust servicing capabilities and adequate origination criteria support Fitch-rated Mexican equipment lease ABS, even in challenging conditions such as during the 2020 pandemic crisis.
Long-established supply chains between Mexican and U.S. industries have thrived under the United States-Mexico-Canada Agreement (USMCA) in the absence of duties. These supply chains rely heavily on the transportation sector, which, in turn, depends on transportation equipment leasing.
Higher tariffs resulting in supply chain disruptions and increased costs may lead Mexican companies to pause or scale back production, capital expenditures and equipment investments. Mexican equipment lessees relying on cross-border trade may see lower income streams with reduced demand and manufacturing volumes, resulting in higher lease delinquency and default rates.
A contraction in demand for industrial and transportation equipment could lead to an oversupply in the secondary market and diminish recovery values, reducing ABS transaction liquidity following a lease default.
Residual value realization depends on market demand at asset maturity. Reduced economic activity due to tariffs might lead obligors to opt against exercising purchase options, leaving lessors with non-productive assets. This scenario can impair expected cash flows from residual value realizations, posing risks to ABS note repayment.
Fitch applies stresses in its rating analysis according to the “U.S. Equipment Lease and Loan Criteria” to evaluate ABS ratings’ resilience and build in a margin of safety to materially adverse economic conditions. Stresses include severe default rate assumptions, maximized obligor concentration, low recovery rates and haircuts to residual value assumptions.
In addition, equipment ABS transactions have structural mitigants that help protect ratings from rising default rates and a decrease credit protection in the form of overcollateralization (OC). Most transactions incorporate mechanisms like default triggers tied to expected default rates that initiate early full turbo amortization if breached.
Liquidity triggers reallocate cash to maintain excess spread levels and reduce reliance on new assets when a change in a transaction’s cash/portfolio composition threatens to decrease excess spread levels and restrict cash disbursement back to the originator. This could occur if decreased demand for new lease agreements leads to insufficient asset transfer to meet target OC during revolving periods, resulting in cash accumulation within transaction structures.
Tariff-induced trade shifts could impact some sectors more than others. Securitizations incorporate mechanisms to counteract OC level declines because of industry, asset type and obligor limit concentrations. OC normally excludes assets above specified concentration limits. When it falls below predefined thresholds, automatic triggers initiate early amortization, enhancing OC and protecting transactions against asset deterioration.
