Below are the key data points we are watching and the positives and potential opportunities we see for the consumer ABS sector, despite the current headwinds.
What We Are Watching
1. The Unemployment Rate: Given the rapid increase in unemployment, we expect defaults and losses to spike during the next four months, reaching roughly three to four times pre-COVID-19 levels. However, we also expect a reversal as people return to work.
2. Used Car Values: Loss recoveries should decline as auction house closures put collection processes, specifically auto repossessions, on hold. When auction houses reopen, we anticipate lenders and rental car companies will start to move their inventory to auction. This dynamic could depress used car values over the short term, but it may be short-lived depending on how fast original automotive manufacturers restart production.
3. Voluntary Prepayments: Auto loan prepayments should decline with people out of work and not shopping for new vehicles. Additionally, many lenders outside of the prime space have tightened lending standards in this environment, making it much more difficult for consumers to obtain new loans.
4. Performance of ABS Deals from April-July: There will be a one- to two-month lag in realizing performance declines in ABS deals. This is because remittance reports come out once a month, and the use of payment extensions is expected to rise. The April remittance report covered the entire month of March, and the first two weeks of the month still benefited from the strong tax refund season. Also, geography played a role as not all states were in a lockdown. Some people were still working and did not need payment extensions. Second, payment extensions push out defaults and losses as interest accrues but missed payments are tacked on to the end of the loan.
5. Issuers' Extension Policies and Use of Extensions: Issuers across consumer ABS sectors have been issuing payment modifications to those who need them. In subprime auto, payment extensions (typically in 30-day increments) are the common option. In the prime auto and student loan spaces, extensions vary from 30 to 90 days. The use of extensions or forbearance will move out defaults and losses, though we do not think that everyone who receives an extension will default. For example, following natural disasters (when these programs are typically deployed) borrowers have tended to resume paying when they have returned to work. However, some borrowers are never able to catch up and ultimately default 30 to 60 days later than they originally would have.
6. Headline Risks: The lag in reported performance poses a headline risk. We could see the loss and default spike come to fruition just as people return to work and things “look better.” Ugly performance numbers may not go unnoticed by the press even though they reflect “old news.”
7. Changes in Payment Hierarchy: The consumer payment hierarchy still holds. Cellphone bills top the list (most people can’t or aren’t willing to live without a cellphone), mortgage/rent payments (everyone needs a place to live), auto payments (cars are necessary when people can go back to work), credit cards (a utility that can be maintained with only a minimum payment), student loans (they are bankruptcy remote, borrowers cannot get out of them) and lastly, consumer loans (since consumers have already benefited from the cash).
Positives in the Consumer ABS Sector
1. Stimulus Checks: For some subprime borrowers, stimulus payment could represent an increase in their typical income. The exhibit below illustrates how some consumers could make more money by staying home than by working. Numerous subprime issuers have highlighted this point.
2. Increased Savings: Another reoccurring theme we have heard from lenders is a possible shift in consumer saving behavior. Specifically, a hoarding mentality could take hold and change how consumers view money, translating into reduced spending and increased savings rates.
3. Term Asset-Backed Securities Lending Facility (TALF): Many issuers we have spoken to do not plan to issue TALF-eligible deals (either because spreads in their sector have tightened or because they issue bonds down the capital structure that are not eligible for TALF). However, we believe the program’s existence and implied government support should still benefit the consumer ABS sector in general through spread tightening.
Opportunities in Consumer ABS
1. Despite structural protections and continued cash flows, consumer ABS has underperformed corporate bonds. Consumer ABS sector spreads are off the wides, but they are still two to six times wider since the start of the year. We believe there are attractive opportunities across asset classes in the top of the capital structure and in selected lower-rated issues.
2. However, strong sponsorship is key! We believe it will be important to hold securities with a sponsor that has strong servicing platforms in place, a seasoned sector-knowledgeable management team, and the financial wherewithal to support a deal if needed. All consumer ABS sectors, from subprime auto ABS to personal consumer loans, have some issuers that meet these criteria.
3. Structure is also important. Here, we are focusing on delevered deals that have built up higher levels of credit enhancement or new issues that are being issued with higher amounts of credit support for the potential uptick in losses.
Disclosure
This material is provided for informational purposes only and should not be construed as investment advice. Any opinions or forecasts contained herein reflect the subjective judgments and assumptions of the author only, and do not necessarily reflect the views of Loomis, Sayles & Company, L.P. Investment recommendations may be inconsistent with these opinions. There is no assurance that developments will transpire as forecasted and actual results will be different. This information is subject to change at any time without notice.
This is not an offer of, or a solicitation of an offer for, any investment strategy or product. Any investment that has the possibility for profits also has the possibility of losses.
Market conditions are extremely fluid and change frequently.
Past market performance is no guarantee of future results.
MALR025452
