Consumer ABS sectors, including autos and credit cards, have shown comparatively good credit performance throughout the recession and during the subsequent period of "lethargic recovery." This is an indication of the U.S. consumer's resilience when faced with a weak economy. It also demonstrates the timely efforts by asset originators to manage risk during the downturn, according to a report published today by Kroll Bond Rating Agency (KBRA).
Since 3Q08, consumer debt levels and leverage have dropped, which improved the overall profile of the consumer’s balance sheets. But, considerable concerns still exist, the rating agency said. While unemployment is dipping and income is increasing slowly, the risk of another economic downturn is still high, specially considering the uncertainty surrounding the resolution of U.S. and European fiscal issues.
It is important to recognize that much of the recent reduction in the level of consumer debt is due to reduced mortgage debt that can be a result of the ongoing housing market weakness. The overall reduction in consumer debt levels is positive even though consumers have less alternatives for managing their non-mortgage debt and household wealth has dropped because of the housing price weakness, the rating agency said.
Rising Student Loan Debt
Additionally, KBRA analysts said that student loan debt has grown rapidly. Outstanding loans in the sector currently exceed total outstanding auto and credit card debt.
The unprecedented debt level among younger borrowers can affect their future overall consumer credit performance. Origination standards in sectors such as subprime auto, which tightened considerably during the downturn, have been relaxed in the past year. The origination volume has increased considerably with the sector attracting investment capital, KBRA said.
In previous economic cycles, buyers can expect many years of strong credit performance during recovery phase. In KBRA’s view, there is a heightened risk that in the current cycle, this may not be the case. The consumer’s current struggle to de-lever together with the risk of renewed increases in joblessness and rising leverage among some of the most vulnerable borrowers, are all reason for caution in looking at consumer ABS credit risk, the rating agency stated.
Although auto loans and the credit card ABS segments have performed rather well in the past several years, KBRA continues to monitor their performance trends. In sectors where competition has increased rapidly, KBRA is closely looking at industry trends and developments. The rating agency said that tighter underwriting standards implemented at the beginning of the Great Recession have eased somewhat in many of the consumer ABS sectors. However, there has not yet been a significant performance impact in any individual sector due to these, analysts said.
Student loans have seen higher default rates in the past few years as shown in the cohort default rate reported by the Department of Education , they added. The default rate for the 2010 cohort year has risen to 9.1% from 8.8% for the 2009 cohort year and is at its highest level since 1996. The cohort default rate is the percentage of borrowers who enter repayment in a fiscal year and default by the end of the next fiscal year, KBRA analysts explained. The unemployment rate for young graduates, along with an increasing student loan debt burden as well as the chance of slower income growth might further negatively impact student loan ABS performance, KBRA said.
KBRA also noted some other headwinds such as the level of economic uncertainty related to yesterday's presidential election, potential U.S. federal government “fiscal cliff” and the current crisis in European sovereigns and their banking system.
Analysts said that given the strong macroeconomic and political drawbacks, future consumer ABS performance will rely mostly on the levels of unemployment, income growth, interest rates and consumers’ ability to manage their debt levels.
Additionally, they said that originators’ ability to adapt to this changing economic and credit scenario and to maintain underwriting discipline still has to be tested. Their success in surviving the test will be an added key factor in keeping the consumer ABS' generally positive performance, analysts said.