Aggregate household debt balances are on the rise, surpassing pre-pandemic levels. But widespread consumer financial distress is far from certain, and asset-backed securities should remain in favor with investors, say industry observers.
Aggregate U.S. household debt balances reached $17.06 trillion in the second quarter of 2023, up by $2.9 trillion since the end of 2019. Credit card balances rose by $104 billion to $1.03 trillion in the same period, performing worse than other debt categories and surpassing $1 trillion for the first time, according to the Federal Reserve Bank of New York's Quarterly Report on Household Debt and Credit.
In a comment on the New York Fed's report, Moody's Investor Service forecasts a peak of 9% -10% credit card and auto delinquencies in 2024 versus 7% pre-pandemic. The credit rating agency also expects residential mortgage delinquencies to continue to rise, likely not reaching pre-pandemic levels until 2024.
Debt delinquency of 90 days or more for total household debt was around 1.5% at the end of Q2 2023, according to Moody's. "This rate will at most reach 3% in 2024, the level seen in 2019," said Warren Kornfeld, Moody's senior vice president of Financial Institutions.
Increasing consumer credit and inflation are a common concern in the market, said Rob Scott, a portfolio manager of structured products at Ameritas Investment Partners.
A break in the storm
Nonetheless, there is little evidence of widespread financial distress for consumers, according to the New York Fed. "American consumers have so far withstood the economic difficulties of the pandemic and post-pandemic periods with resilience," its
Tracy Chen, a portfolio manager at Brandywine Global, links the outlook for consumer ABS performance in 2024 to consumer fundamentals, which look solid in aggregate.
"The job market is still tight, and total household assets are over $140 trillion, relative to $14 trillion liabilities," she said.
Although credit card payment rates, charge-offs and delinquencies have deteriorated from one-year-ago levels, performance metrics are still generally better now than they were in 2018 or 2019, said Herman Poon, a senior director in Fitch Ratings' ABS group. "Another mitigating factor for credit card ABS is the existence of very seasoned accounts within ABS trust pools that contribute to their health, and we haven't seen issuers diluting the pools with riskier accounts as yet," he said.
Low unemployment has led to strong performance across ABS sectors, as measured by default frequency, said Margaret Rowe, a senior director in Fitch's North American ABS group.
Unsecured consumer installment ABS have seen higher defaults but are maintaining their stable ratings because of relatively fast amortization and the credit enhancement and subordination that have built since closing, said Harry Kohl, a senior director in Fitch's ABS team. Kohl expects some increase in ABS issuance along with tighter credit underwriting.
Fitch expects the U.S. to enter a mild recession in Q4 2023 or Q1 2024. It also forecasts asset deterioration for most ABS sectors for the rest of 2023 relative to 2022.
Nonetheless, the ratings outlook remains positive, Rowe said. She points to the short duration of auto ABS notes, where even the most junior notes pay off relatively quickly. "They are also structured to increase protection as the loans are amortized," she said.
Investors stay the course
Amy Martin, a senior director at S&P Global Ratings, expects consumers to continue using loans for auto purchases because vehicle prices are elevated, and consumers have spent much of their pandemic-related savings. "If higher-income households rely more on cash for purchases such as autos to avoid high interest charges for loans, that could have a small impact on prime issuance," she said.
"I favor ABS in general and believe shorter (ABS issues) and deleveraging is a defensive alternative to equities or to investment grade and high-yield corporate bonds, given current valuations and the murky economy," Ameritas' Scott said.
The short duration of consumer ABS is an attractive feature for investors, James Intermont, managing director at Atalaya Capital Management, noted.
ABS yield is another attraction for investors. "If the Federal Reserve reaches the end of the hiking cycle, then ABS might offer attractive yield opportunities with above average spreads versus treasuries today, said Greg Handler, head of mortgage and consumer credit at Western Asset Management, a Franklin Templeton affiliate.
"ABS remains an efficient form of funding for lenders, and we expect auto and credit card ABS issuance to remain stable in the near term," Fitch's Poon said. "AAA rated bonds will continue to be issued, but we are seeing some issuers retain the junior tranches for themselves."
