Delinquency rates for consumer ABS have been rising for several quarters, and the trend is expected to continue at least for the remainder of this year and into 2025, analysts at Columbia Threadneedle said in a recent media roundtable on risks and opportunities in consumer and corporate credit in a changing rate environment.
Despite that increase, U.S. consumer asset-backed securities (ABS) can deliver a competitive risk reward profile for investors, the presenters said.
The fact that these [prime] borrowers are becoming delinquent is ... eye-opening.
Delinquencies among borrowers with FICOs above 700 are starting to rise, even though they are still very low, Dan Liesener, senior research analyst, structured assets, at Columbia Threadneedle, said.
"The fact that these borrowers are becoming delinquent is something that is eye-opening," Liesener said, "especially [among] auto loans which have historically had a very high payment priority for U.S. consumers."
Credit score inflation during the pandemic was an important contributor to latter delinquency rates, Liesener said. Higher consumable goods prices, rising interest rates and a softening labor market also affected credit quality.
The Impact
Eventually, the implications for household debt became clear. According to the New York Federal Reserve's Q2 2024 Household Debt and Credit report, total household debt increased by $109 billion (0.6%) between Q1 2024 and Q2 2024 to $17.80 trillion. Delinquency transition rates for credit cards, auto loans and mortgages increased slightly in the second quarter.
Over the previous 12 months, approximately 9.1% of credit card balances and 8% of auto loan balances transitioned into delinquency, the New York Fed said.
Rising household debt has had varying effects on consumer ABS, depending on vintages and issuers. Ines Beato, senior vice president and sector lead for U.S. ABS ratings and consumer assets at Morningstar DBRS, is seeing an overall deterioration in ABS performance. So far, 2022 and 2023 vintages are probably the worst performing, and, while it is a little early to comment, 2024 might follow a similar trend, Beato said.
2022 and 2023 vintages are probably the worst performing, and, while it is a little early to comment, 2024 might follow a similar trend
"Rising rents, increased cost of goods and higher interest rates are putting pressure on all consumers, sending personal savings to all-time lows," she noted.
According to Moody's August 2024 U.S. consumer ABS and RMBS report, "High costs and rates remain negatives for pools as strong job market cools," payment burdens on new household financing have risen in recent years due to higher interest rates and loan sizes. This added to consumer stress after a period of elevated inflation and depressed savings rates. Moody's says this pressure will remain a credit negative for recent and new vintage transactions. There are signs, however, of a plateau in the costs of new borrowing and an easing of inflationary pressures more broadly, the ratings agency said.
The subprime sector, with the least amount of cushion, is most affected, but the middle range of the credit spectrum is also impacted. The top end of the credit spectrum is likely to follow, with student loans potentially taking a similar path.
"There is a continued deterioration in consumer finances, because wage increases haven't kept up with rising monthly expenditures," Beato said. "We're seeing the demand for personal loans increasing, and more originations to higher FICO obligors."
The Impact by Assets
These trends can be seen across different consumer asset classes, Beato said. The largest amount of deterioration thus far is probably in autos and unsecured consumer loans. So far, marketplace lenders are more affected than branch-based lenders, likely the result of different underwriting methods and loan purposes.
Liesener's observation is in line with Beato's. While the rising delinquency is mostly affecting lower quality loans, prime and prime borrowers are also starting to experience strain, he said.
Comparing 2024 auto ABS deals with 2019 deals from the same issuers, Liesener noted higher loan balances and interest rates. "So, your monthly debt service to make the payment on the exact same bucket of items that you would have bought pre-COVID, is now about 30% higher," he said.
Beato expects to see further ABS deterioration in 2024 and 2025. Tighter credit underwriting, better pool composition, and elevated pricing for relative levels of risk, however, will offset some of that slide.
Reasons for optimism
Consumer ABS might have developed a reputation, for some, as an investment to avoid, especially given the expectation for continued credit deterioration. Columbia Threadneedle's Liesener doesn't see it that way, however, and says the company is not avoiding the sector. In fact it's one of the company's favorites, because structured finance products can adapt to changing economic environments, he said.
"Structures have adjusted to become more bondholder-friendly," Liesener said. He added that deals have higher levels of credit enhancement. Cash flow priorities have also changed especially among issuers that have experienced the biggest increases in delinquency rates.
Senior positions and newly issued ABS offer more yield than subordinate positions were offering not long ago.
Beato also points to the increase in credit enhancement, a result of issuers striving to meet rating agency criteria. For many seasoned securitizations, credit enhancement grows as the pool amortizes, she said. The mechanics allow for growth in credit enhancement, which generally offsets any worsening performance as the notes pay down.
"Because of the deleveraging, sequential pay structures, we have confirmed or upgraded most of the ratings that we've reviewed," Beato said.
Another point in favor of consumer ABS is the returns that they now offer.
"Senior positions and newly issued ABS offer more yield than subordinate positions were offering not long ago," Liesener said. He also sees pockets of subordinate risk where there are outsized returns.
