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Consumer loan ABS survived COVID-19, but what else is in store?

Amid the economy’s recovery from the COVID-19 pandemic, and the reopening of the U.S. economy, consumer-related debt has taken a surprising turn by turning in credit performances that were better than expected. But market observers say the conditions that made better consumer credit possible, especially consumer installment loans, are not likely to come around again in the next economic downturn.

As consumers benefited from major programs like student loan and mortgage payment forbearance programs, they used the windfall to pay down debt and build up savings.

“Unprecedented levels of federal relief such as enhanced unemployment benefits, direct stimulus payments, and sweeping forbearance programs have supported credit performance across consumer lending markets during the pandemic,” Elana Lipchak, an ABS strategist on the Bank of America global research team said in an email response.

Asset-backed trusts continue to see the benefits of how consumers allotted their stimulus and relief payments. Consumer loan ABS, like other consumer-oriented debt, posted credit performance results that were better than expected, even through recent months, according to Bank of America Securities.

Part of that performance is owed to the marketplace loan segment, which accounted for slightly more than one third, 33%, of total consumer loan ABS volume year to date, according to BofA.

The net loss rate for marketplace loan ABS was 4.4% in May 2021, slightly higher than where it bottomed out at 4.3% in October 2020, according to the most recent data available.

In the year leading up to the pandemic, the net loss range was 6.0% to 8.5%, and was still lower than the 12% that it had reached in 2016 and 2017. That was partly due to a couple of market dynamics had deprived the marketplace loan ABS pipeline of fresh deals to begin with. A challenging economic environment in 2020 diminished demand for loans. Also, marketplace lender diversified their funding sources, by acquiring banks or issuing pass-through securities. In terms of the latter, sponsors of marketplace loan structured finance deals issued about $7.6 billion in pass-through certificates.

With all of the support, the severe jumps in unemployment rates did not translate into higher delinquencies, unlike during prior recessions. True, unemployment levels hit 14.7% in April 2020, a shocking increase from 3.5% in February 2020, according to data from the Bureau of Labor Statistics.
Economic indicators have improved significantly since one year ago. The unemployment rate rose to 5.9%, when observers expected a drop to 5.6%. The shift coincided with the economy adding 850,000 jobs to the payrolls in June, beating the estimate of a 720,000 gain on payrolls.

The state of the economy looks promising now, but Bank of America’s concern is for the next recession, Lipchak said.

“The government may not take such extraordinary measures,” she said. Should that happen, Lipchak added, the bank expects the normal relationship between rising unemployment and higher delinquencies and defaults to take form.

As it relates to an asset securitization collateral pool, personal installment loans generally rank toward the bottom of a payment hierarchy after auto loans, mortgage and rent, and credit cards.

“This should result in weaker credit performance,” Lipchak said. The near-term picture looks more positive. “The improving employment situation, continued benefit from stimulus and savings, and tighter underwriting standards should be supportive through the remainder of 2021.”

Now what is a true lender?

Recently President Joseph Biden signed a resolution that repealed a regulation from the Office of the Comptroller of the Currency that determined when a national bank or federal savings association makes a loan and is identified as the so-called true lender.

The rule, passed just in last October, stipulated that a bank is a true lender of a loan when it is named as the lender in the loan agreement and funds the loan, at the time of origination. Also, if at the time of origination, one bank is named as the lender in the loan agreement and another bank funds the loan, the bank that is named as the lender in the agreement funds the loan, Lipchak said.

As such, as the true lender, the bank will retain the compliance obligations associated with the funding.

But President Biden’s authorization of the repeal introduces uncertainty to the asset class, in a way that would increase legal uncertainty, discourage partnerships and chill innovations that emerge from such partnerships, Lipchak said.

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