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The US ABS market is confident… but must be careful

Tightrope walker concept of risk taking and challenge

Faith in deal structures post-2008 has the market believing it can withstand a recession in 2023

US economic data has been something of a mixed bag of late, but the bag appears to be getting worse and worse.

On Tuesday, the IMF downgraded its growth forecast for the US by 1.4% to 2.3% and said that “US consumer spending undershot expectations”.

At SFVegas last week, the CEO of credit-score developer VantageScore said their US consumer metrics were showing “worrying trends”, while S&P’s senior director in non-traditional structured finance, Deborah Newman said the rating agency was now predicting a 35%-45% chance that the US would enter a recession in 2023.

Meanwhile, Citi expects a 100bp rate rise from the Federal Reserve later this week.

Yet despite what the IMF called “gloom and uncertainty”, market participants in US securitization remain pretty bullish.

GlobalCapital saw this first hand at SFVegas last week. There were investors talking up the opportunity to gobble up cheap deals for what they perceive to be minor increases in risk. One investor described an asset class as providing “equity like returns for debt like risk”.

So long as issuers are able to pass higher cost of debt onto the customer, which so far, they have, it does not seem problematic. Banks too have insisted that deals will continue to flow through the market, with the exception that spreads may just be slightly wider.

All things considered, there seems to be an awful lot of confidence in the securitization market.

That confidence stems from two factors: the sector’s resilience through the dark days of the pandemic, alongside greater discipline and strength in the aftermath of the 2008 global financial crisis.

Many panellists at SFVegas spoke of their faith in the “resilience” of the structures behind deals. Greater levels of credit enhancement, stress tests that investors can trust, and the fact that lenders are no longer giving out mortgages to totally unqualified borrowers (as Michael Lewis described) have given good reasons for that faith.

While in the aftermath of the pandemic panic, most asset classes (apart from aircraft ABS) came through with flying colours.

The two points are linked too, with the pandemic response providing a recent example of the very resilience that the panellists spoke of.

But there are caveats. Would US securitization markets have been so “resilient” had the unprecedented level of government support in the US and across the world not been rapidly introduced? Unlikely.

Similarly, in the residential housing market there have been huge crashes before, while commercial real estate is still adjusting to post-pandemic changes in how office space is used. Will the structures be so resilient if valuations suddenly dropped?

With uncertainty and volatility easy to find, there have been some who have, privately at least, admitted their concern should a recession hit. But those concerns can be a positive force, focussing minds.

This time around, as the global economy ends what BlackRock’s global chief investment strategist, Wei Li called “the great moderation” of low growth, low interest rates and low inflation, confidence in the resilience of US securitization is a cause for optimism. But let’s be careful.