Consumer ABS less plain vanilla as credit cycle ages

Traditional consumer ABS asset classes, particularly auto ABS, are looking less like on-the-run, flow assets than they once did, panellists said at SFVegas 2020 on Monday. As the credit cycle stretches on, speakers cautioned the audience to keep an eye on the growing risks in deep subprime consumers and the rise of revolving auto ABS structures.

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More than 10 years into the credit cycle, the general consensus is that consumer fundamentals still look relatively strong — judging from metrics such as job creation, wage growth and GDP growth.

To support that argument, the overall theme at SFVegas this year seems less focused on calculating what stage of the cycle the market is in compared with the 2019 conference, and more on finding creative ways to put capital to work as low interest rates persist, sources told GlobalCapital.

However, consumer ABS may be exposing investors to more risk than they expect. Taking a closer look at certain segments of the consumer market, particularly the bottom 40%, the US consumer is showing signs of struggling, according to Loritta Cheng, director at MetLife Investment Management.

Deep subprime consumers are being squeezed by slow wage growth, said Cheng, relative to high inflation of necessary expenditures such as education and healthcare. These signs of struggle are not yet showing up in actual ABS deals, owing to sufficient credit enhancements, but nonetheless the deals need to be closely monitored by investors.

“We see signs of stress,” said Gerald Fahner, senior principal scientist at FICO’s scores division. “For example, in auto loans and credit cards, we see relationships between the FICO score and delinquencies deteriorating.”

And as the risks within consumer ABS shift, so does the structure of these deals, said Brian Kustrup, a trader at Crédit Agricole.

In 2019, credit card ABS issuance dropped significantly, leaving fewer revolving ABS-type risk opportunities for investors to put their money into. To fill that void, auto ABS issuers have been issuing more bullet structure, revolving ABS deals to cater to the demands of the investors.

For example, Santander issued its first revolving subprime auto ABS in November 2019. The transaction has a five year period in which the issuer can add more retail subprime loans to the portfolio on an ongoing basis. The deal enjoyed a high level of demand, as expected, with total size increased by $200m and notes 1.5 to three times oversubscribed. Toyota and Ford issued similar revolving type deals in 2019.

Due diligence is more important in these kinds of revolving deals, pointed out Alin Florea, vice-president at Barclays, because investors need to develop a longer view of the sponsor’s ability to continue underwriting consistently over and over again through cycles. Moreover, the higher loan-to-term ratios and the prevalence of loan terms as long as 72 or even 84 months in many of these deals is worth monitoring because  “none of this has ever really been tested yet”, said Cheng.

Panellists also said that any deterioration in marketplace lending ABS, particularly among newer fintech lenders, will be the canary in the mine when the recession nears.

“Even if you are not an investor involved in the sector, I urge all of you to pay attention because it could be the first to show signs of stress when the credit cycle starts to turn,” said Florea.