The asset-backed-security (ABS) market should be “largely stable” in 2022, but the prolonged COVID-19 pandemic, coupled with inflation, may hurt segments of the sector, structured finance experts at Fitch Ratings said at a recent conference.
“We’ve seen some volatility in the last several weeks related to the impact of the omicron variant on the economic recovery coupled with increasing concern over inflation shock that has caused Fitch and other forecasters to anticipate the Fed to raise interest rates materially sooner than we previously expected,” said Michael Paladino, head of North American Structured Finance for Fitch, at the virtual Credit Outlook North America 2022 conference on January 20.
Analysts at the meeting expect that interest rates will be raised twice this year and four times in 2023.
Tests ahead for student loan ABS
When looking at specific asset classes, analysts expressed concerns about student loans ABS collateralized by the Federal Family Education Loan Program (FFELP), which is expected to deteriorate by Fitch analysts. Sluggish payment rates, the increase in rates of Income Based Repayment (IBR) are cause for concern by analysts. In 2021, two trusts experienced default and more trusts may default “if issuers do not receive necessary investor consent to extend maturity dates,” Fitch concluded in a recent report.
Fitch expects delinquencies and defaults for FFELP ABS to normalize near to the pre-pandemic level, which is higher than the current low rate of 2%. Also, IBR rates are picking up in the student loan sector and it’s something that forecasters will monitor throughout the year.
Recently, student loan processor Navient reached a deal to cancel the debt of student borrowers after the government accused it of predatory lending. However, Fitch analysts don’t expect that settlement to materially impact the student loan ABS sector.
Navient is expected to recover or cancel $50 million in loans, and whatever was securitized would have been in legacy trusts that originated between 2003 and 2008, said Ian Rasmussen, senior director, U.S. ABS. From a trust perspective, he added, those loans would have either defaulted or charged off by now.
Consumer-driven concerns
As for core consumer ABS sectors such as auto and credit cards, Fitch said. However, the subprime retail credit card , auto and student loan sectors are expected to be more likely to fall prey to performance volatility, particularly if account holders’ economic status wanes, experts said.
The timeshare sector is more susceptible to performance volatility in 2022 due to the increase in the omicron variant of COVID-19, and perhaps any new variants we may experience throughout the year, Rasmussen said.
“We are certainly watching very closely the new variants and how they may impact mobility,” Rasmussen said.
Rasmussen said that there is an uptick in longer term loans up to 84 month car loans. Fitch will watch to see if it impacts default performance. Early defaults on those contracts can drive overall losses higher, while depreciation outpaces loan amortization. Lenders often extend longer terms to the highest credit quality borrowers.
In addition, the used car market, which was white-hot due to supply issues during the pandemic, should moderate due to easing of financial stimulus from the government that boosted demand for the vehicles.
Normalization is expected in the credit card sectors, too. Forecasters are watching the monthly payment rate; currently, it sits at historically high levels. It might be a strong leading indicator of any deterioration of household balance sheets, however. It could also raise flags about changes in consumer sentiment as a result of increasing pandemic pressures with new variants such as o micron, Rasmussen said.
Other sectors such as multifamily, hotels and industrial commercial mortgage backed securities (CMBS) are expected to improve. Residential mortgage backed securities (RMBS) analysts see continued home price growth - albeit at a slower pace than 2021 - and increasing asset performance. The RMBS analysts will also keep abreast of any government products that could impact the sector.
