Excellent credit Excellent credit https://stage-fii.federatedinvestors.com/static/images/fhi/fed-hermes-logo-amp.png https://stage-fii.federatedinvestors.com/daf\images\insights\article\credit-card-reader-small.jpg May 13 2022 May 11 2022

Excellent credit

The asset-backed securities market continues to shine.

Published May 11 2022
My Content

In a typical period of stock volatility, asset-backed securities (ABS) are an attractive alternative. But with pandemic-  and war-related disruptions driving inflation, this market truly is standing out—and for not so obvious reasons.

The reason is simple: ABS performance largely is contingent on the financial health of consumers, and they are doing fine. Actually, better than that due to fiscal stimulus, pent-up demand and a tight labor market. While falling from last year’s stimulus-driven peak, savings rates for prime borrowers are near historical highs, wages keep rising and the unemployment rate is 3.6%. All four of the broad categories of ABS have a positive story to tell. And we think their narrative will remain for some time.

  • Credit card performance continues to benefit from consumer strength, bolstered by a low unemployment rate, plentiful job openings and an elevated desire to pay down debt. The Fitch U.S. Prime Credit Card Index continued to show improving metrics. Compared to February 2020 (pre-pandemic), credit card gross charge-offs have fallen dramatically, down from 2.9% to just below 2%. Additionally, as measured by monthly payment rates, consumers are repaying credit card debt as quickly as ever. In fact, the Fitch index reported an all-time high monthly payment rate of 44.7% in April 2022, much higher than pre-pandemic levels of approximately 30%.
  • Autos are benefiting from the situation bedeviling manufacturers, dealers and customers. The shortage of chips and new vehicles is causing used automotive prices to remain elevated. Credit is probably the best we’ve seen in years. But if someone defaults on a loan, the car/truck is sold at auction for a high value, resulting in high recovery rates and low losses. Leasing is also strong, as holders are willing to buy out more vehicles instead of returning them—and if they do return them, the gains are near all-time highs. This all lowers residual risk. Although used car prices have recently declined, they are still up 14% year-over-year through April 2022. In addition, structural features of auto lease deals still provide ample protection to bondholders even if used car prices begin to drop materially.
  • Equipment issuance has been high—and high-quality—this year, especially in the agricultural and construction sectors. The surge in prices due to the demand for commodities (including corn, wheat, soy; mined ore and minerals) has given farmers, mining companies and the like more funds to make the payments on their loans and leases. This in turn has led to an increase in demand for the equipment, pushing resale prices higher. In fact, some repossessed machines have sold for more than the remainder owed on their loans, creating a net gain instead of the usual loss. Boosted by continuing adoption of the work-from-home movement, IT/office equipment deals also are experiencing historically excellent performance, with residual realizations above the 10-year average. Furthermore, this issuance is primarily backed by larger institutions that built healthy balance sheets during the pandemic.
  • Student loans continue to hold value, specifically private lending. Federal student loans compose approximately 92% of outstanding student debt. But the share of private lending has grown, accounting for roughly 70% of new issuance over the past three years. Since the pandemic, private student loan pools have experienced lower defaults and delinquencies while prepayments have risen, as borrowers have improved household balance sheets by repaying student debt more quickly. Finally, politicians continue to debate the merits of federal student loan forgiveness. We would view any such action as beneficial for borrowers (and consequently ABS trusts), who potentially could reduce other outstanding debt.
Tags Fixed Income . Markets/Economy .
DISCLOSURES

Views are as of the date above and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector.

The value of some asset-backed securities may be particularly sensitive to changes in prevailing interest rates, and although the securities are generally supported by some form of government or private guarantee and/or insurance, there is no assurance that private guarantors or insurers will meet their obligations.

Bond prices are sensitive to changes in interest rates, and a rise in interest rates can cause a decline in their prices.

Fitch’s U.S. Prime Credit Card Charge-Off Index monitors credit card activity at major U.S. banking institutions.

Federated Investment Management Company

1284098219