There's been a lot of talk about how "the resilient consumer" continues to hold the line against mounting pressures in the economy. After mid-December brought lower than expected inflation, and the Federal Reserve raised the prime interest rate by a less hawkish 0.50%, there was reason to believe resilience could also sustain securitized pools.
If consumers are struggling to service unsecured debt such as credit cards, then securitized pools are not seeing outsized effects just yet. Also, while analysts generally expect the U.S. economy to experience a mild recession in mid-2023, and they say the impact on the all-important consumers will vary, depending on the type of debt and the consumer income segment.
Marketplace loans, the unsecured consumer loans often originated through online platforms, are important to watch, because consumers are more likely to prioritize making payments on mortgages and rents, automobile loans and credit cards, Ian Rasmussen, a managing director and co-head of ABS research at FitchRatings said in emailed comments.
"Weakness in performance has been observed in the marketplace lending index and a key driver of this is the increasing composition of outstanding marketplace loan (MPL) ABS to sponsors originating to near or non-prime borrowers," Rasmussen said.
Performance has been good in the credit card sector, Theresa O'Neill, an ABS strategist at BofA Global Research said in an interview. O'Neill added a caveat, though.
"Banks have had to increase reserves," she said. "Some of that was due to loan growth and otherwise, due to a weaker expected economic environment, banks have had to provide for a loan loss."
The cost of price stability
With December's hike, the Federal Reserve has raised its central interest rate by 4.25% points this year, bringing the interest paid on reserve balances to 4.25% to 4.5%.
The Fed's quest to tame inflation already has the nation's largest banks predicting economic weakness for 2023. The U.S. economics research team at BofA Securities expects Gross Domestic Product for Q1, Q2, Q3 and Q4 of 2023, to reach -1.0%, -2.0%, -1.5% and +1.0%, respectively, O'Neill said.
As for how these changes are impacting consumers right now, Fitch analysts say credit tightening is underway, and more so in the unsecured consumer assets.
"We have seen increasing terms, although not all increases are tied to concerns about credit," Rasmussen said. For instance, mobile handset carriers extended terms to because consumers are keeping their older—yet technologically sophisticated and pricey—phones longer. In prime auto ABS pools, Rasmussen noted, higher credit quality borrowers benefited from longer terms in the underlying leases.
Consumers are holding strong, yes, but credit markets expect that the economy will experience a mild recession by the middle of 2023, Rasmussen said. High inflation is also expected to drag on real wages, contributing to the recessionary outlook.
Is this paper over the cracks?
While some of the nation's largest banks—Bank of America, JPMorgan Chase and Wells Fargo—reported quarterly earnings results in their credit card businesses, they noted declines in charge-off rates, even as spending increased. This suggested that consumers were keeping up with debt servicing in ABS pools, even as they took on the higher debt levels that the Fed found in its study.
Rasmussen says that Fitch is seeing that trend reflected in ABS performance. Monthly payment rates are over 40% in prime pools, up from about 30%, and they are looking stable. Chargeoff rates in prime credit card ABS pools have been falling since February 2021 (just under 3%) through June 2022 (shy of 2%), Fitch found in its Q4 2022 U.S. Consumer Health Monitor.
The stronger performances in prime credit card ABS demonstrates how higher inflation is impacting various consumer segments differently. The question for the industry is whether that resilience will last.
"We're looking for modestly to moderately weaker performance for consumer credit," O'Neill said.
Keep watch on unemployment
BofA analysts also expect the unemployment rate to end the year at 5.6%, O'Neill said. True enough, O'Neill says, the GDP pullback view probably doesn't fully reflect the 5.6% unemployment rate.
That unemployment rate will be important watch, because of the amount of debt that consumers have been taking on lately. In its September G19 study, the Federal Reserve noted that consumer debt had increased by 15% on a year-over-year basis. That consumer behavior stemmed partly from the fact that loan officers had been willing to loosen underwriting standards, according to a Fed Loan Officer Opinion Survey in 2021.
"Our view is that we are very cautious on consumer debt," O'Neill said.
Performance trends among consumer debt sectors—aside from mortgages—is correlated with the unemployment rate. As the unemployment rate increases, most lenders anticipate seeing higher delinquencies and defaults, and this could affect assets like student loans and autos, O'Neill said.
"The securitization portfolios are of very high quality, but remember that they have benefited from loosened underwriting," O'Neill said. "That is the denominator effect."
So heading into 2023, securitization experts emphasize that the unemployment rate, and bank underwriting trends will be among the most important factors to consider when examining securitization portfolios.
How the different consumer segments experience those changes will also play a major role.
"Lower income households are most impacted from inflationary pressures," Rasmussen said. "Stress to unemployment is expected to further impact this demographic segment the hardest."
