The ABS market has made a strong recovery since the first Covid-19 shock in March. Two weeks ago, the market saw the highest weekly volume since before the outbreak, and spreads have continued to tighten this week. In the secondary market, triple-A spreads have come in 4bp-10bp and junior bonds have tightened by 15bp-30bp.
Investor appetite for the bonds is high, but after the $600 expansion in unemployment benefits expires at the end of this week, the outlook for consumers and consumer ABS becomes uncertain.
An immediate outcome will be a rise in delinquencies and defaults for consumer-linked sectors, as lower income borrowers run out of money to service their debts. The US is still dealing with record unemployment numbers and jobless claims, above levels seen during the last financial crisis, which the stimulus benefits have largely masked.
ABS spreads will suffer, though not to the extent that they did when the crisis was at its worst in the spring months, sources said.
There’s a “push and pull” between technicals and fundamentals in the ABS market right now, according to Richard Talmadge, senior analyst at global asset manager Insight Investment. Technicals are favourable, with overflowing liquidity and strong appetite to take in new risk. Some new deals are being oversubscribed by three to eight times, especially for bonds lower in the capital stack.
“When you look at fundamentals, though, it is broadly understood that, as unemployment benefits that helped the lower income consumers expire, subprime auto and some aspects of credit card and unsecured consumer deals will have a lot to lose,” Talmadge said.
In a research note from Wells Fargo, analysts cautioned that it may be “prudent” to move up in credit as the next round of stimulus is negotiated. Double-A and single-A subordinate bonds, in particular, will offer protection against consumer-related volatility while offering attractive spreads, the analysts wrote.
A potential buffer against a reversal in the ABS recovery is the Federal Reserve’s Term Asset Backed Securities Loan Facility (TALF) programme, market participants said. The TALF programme will help support the new issue market when spreads widen out and ensure that the market does not come to a complete stop.
While a partial extension of the unemployment expansion and the Paycheck Protection Program will be passed by lawmakers in coming weeks, key details that benefit the mortgage market are still missing, and will be a “negotiating point” between Democrats and Republicans, according to the Commercial Real Estate Finance Council (CREFC).
As of Tuesday, there is no language around foreclosures, evictions and forbearances in the working stimulus package, and the current federally backed mortgage moratorium provisions expired on July 25.
The unemployment insurance clause is also still being hotly debated, sources said. Democrats have proposed an extension of the $600 weekly benefit, which unemployed individuals have been receiving since April. On the other hand, Republicans are pushing for a $200 weekly benefit plan, on top of state unemployment benefits.
“Even before Republicans can begin negotiating with Democrats over a broad relief package, they are battling each other over the specifics of relief,” CREFC said in a memo released to members on Tuesday. “It is possible that the broad relief package could actually be made up of multiple bills, which will allow Senate leadership to pass bills despite some Republican senators’ opposition to some components of relief.”