Securitization runs hard to keep up with the US consumer
Consumer spending habits have changed beyond recognition since the financial crisis 10 years ago. US households are more wary of debt and are turning away from many of the traditional avenues of spending that have driven ABS markets for decades. While the market has come back since the depths of the crisis, securitization in 2019 is a different beast.
As the engines of the US credit machine have slowed, the securitization model is no longer delivering the volume it once did. As the current economic cycle perhaps enters its last years, outstanding volumes of both residential mortgage backed securities (RMBS) and commercial mortgage backed securities (CMBS) are only just north of 50% of what they were in 2007. However, where real estate backed securitizations are declining, there are some bright spots in the burgeoning market for consumer ABS deals.
Since the financial crisis, homeownership among those aged 25-34 has declined to 37%, versus 45.4% for Gen Xers and 45% for Baby Boomers when they were the same age, according to the Urban Institute’s Housing Finance Policy Center in its Millennial Homeownership report.
A simple explanation for this decline is that younger Americans do not want to buy a home. Fewer people aged 21-37 are married and this group are also delaying having children — historically milestones on the way to homeownership. They are also relocating often to gateway cities and require flexibility for changing jobs andlocations.
However, there are also significant structural economic headwinds possibly throttling rates of millennial homeownership. Lenders have tried to learn the right lessons from the financial crisis and prudentially extend mortgage credit. Likewise, speculative homebuilding is less common than it was in the 2000s.
“Supply constraints are a major reason why millennials cannot afford a house. Even if preferences have changed, some would have become homeowners at this stage of their lives,” says Jung Hyun Choi, fellow at the Urban Institute’s Housing Finance Policy Center.
As these trends apply to the mortgage-backed securities market, a constrained market for residential credit has unsurprisingly meant fewer mortgage-backed securities to issue. Annual mortgage originations have declined overall, and private label issuance has taken a substantial hit. That sector soaked up as much as 40% of all first lien mortgages in the years before the financial crisis. Today, that proportion hovers closer to 1%.
While the government-sponsored enterprises have picked up the slack, the mortgages they are allowed to finance are generally aimed at high-quality borrowers, given that Fannie Mae and Freddie Mac end up guaranteeing that investors in their securities will be repaid in full. Federal Housing Authority loans can target lower quality borrowers, but only if they are first-time purchasers.
Without private issuers willing to take on more risk, mortgage originators simply cannot distribute the same volume of mortgages they once did. And, according to the few originators left in the affordable housing market, it is leaving a broad chunk of Americans out of the capital markets infrastructure that has once encompassed a broader swathe of the economy.
“The level of support on capital markets for non-luxury, higher-end housing is minimal. Absent some support from [Fannie and Freddie] for affordable housing programmes, it’s seen as too risky. But that’s where we see opportunity. Somebody has to step in,” says Pat Jackson, chief executive at Sabal Capital Partners and former executive of IndyMac, a major real estate lender in the lead-up to the financial crisis.
If more Americans are not taking out mortgages, they are also skipping out on another venerated American institution: the great American shopping mall. But while housing may be a story of supply constraints, the shifting landscape for retail and its impact on CMBS appears to represent an evolution in consumer preferences.
“It’s all about changing customer behaviour,” says Manus Clancy, director of research at CMBS and commercial real estate data provider Trepp. “An older generation did all their shopping at malls, including for Christmas and back-to-school [seasons]. But now, nobody is doing this, parents included. Going to a mall needs to have a reason to bring you in.”
While retailers come and go, the continued shrinking of major department stores is pressuring mall owners, who struggle to meet mortgage payments when anchor tenants go dark. That has especially played out for the smaller, B-class malls in highly concentrated markets.
Declining occupancy has in turn put pressure on a number of CMBS deals, which have historically been a stable source of financing to smaller, regional malls that would otherwise struggle to strike a deal with balance sheet lenders.
Delinquency in decline
Yet defaults in CMBS are low. According to data from Trepp, delinquency rates for retail CMBS loans have declined over the past 12 months to 5.55% from 6.63%. Likewise, retail CMBS issuance has ticked up in some markets as investors take bets on re-purposed retail space that include tenants focused on ‘experiences’ rather than shopping alone, and renovating space to make room for cinemas and restaurants.
But elsewhere, securitization has found room to run in the field of consumer ABS deals, which received a great deal of investor attention this year as their short duration and ties to the rebounding consumption economy made it an attractive form of exposure. Wells Fargo forecasts ABS issuance to total $218bn in 2019 — a mild increase from last year’s $205bn of issuance, nearly 75% of which is inside three years average life.
“We expect borrower demand for credit to continue, which should imply additional funding needs for lenders in ABS,” wrote Wells Fargo analysts in a 2019 outlook for structured finance. “Consumer ABS credit trends are likely to remain well behaved, and auto ABS from prime and subprime loans and auto leases should maintain its place as the largest ABS sector.”
Post-crisis, non-mortgage consumer credit outstanding has been led mainly by growth in student loans, which some economists have worried is crowding out other kinds of consumer debt, such as credit cards. But personal loan debt outstanding grew to $273bn as of Q2 2018 according to Wells Fargo, making it the fastest growing consumer debt sector in 2018.
While many personal lenders, such as SoFi and Marlette, have turned to the ABS market, there are lingering concerns about underwriting and borrower performance in an economy with rising rates.
“The introduction of personal loan ABS, especially from those lenders using the internet channel, up to $28bn from zero in 2012, presents a challenge for many investors. Pricing spreads have been at attractive levels, but short business histories make credit analysis and comparisons over time more difficult,” says John McElravey, analyst for consumer ABS at Wells Fargo.
Without question, securitization in 2018 is not financing the same percentage of the real economy that it did in a year like 2006, a year when former SEC Chairman Christopher Cox addressed the American Securitization Forum, telling the audience they played a crucial role in the lives of ordinary Americans.
“Any American with a home, a car, or a child in college — that is to say, millions of Americans — depend on what you do,” Cox said. “Homes, cars, and college tuitions, like so many other things we need, are more often than not financed with loans. And the chances are good that when we finance these necessities, our loans are securitized. It’s also very likely that if they had not been securitized, many of these loans could never have been extended in the first place.”
But today’s pared back market does not exactly represent a foundational shift in US capital markets. Instead, the market has undergone a reconfiguration in how the securitization industry finances consumer activities. And as a new generation comes of age and makes new choices about how to live and invest their time and money, it will accordingly respond to these changes.
Housing credit may be tighter, but there is still a deep and liquid market for investing in MBS, which remain an attractive asset for investors looking for exposure to a mainstay of the US economy.
There may be fewer malls in the US in 15 years’ time, but that will hardly grind the retail segment of the CMBS market to a total stop. Meanwhile, burgeoning forms of consumer credit collateral have found their way into ABS deals in the last few years, with deals backed by marketplace loans, residential solar loans and leases and residential mortgages made to borrowers.
Despite the widespread shifts in how people live and work, securitization has adapted, and while lenders are not as keen to up their exposure to consumer credit risk, especially when it comes to real estate finance, there is ample evidence that they are still willing to participate in funding the real economy.