Quick Hits: The Health of the Consumer

Delinquencies in credit cards and autos have been increasing. Related media coverage often includes an alarmist “highest since the GFC” reference. Are ABS structures designed to withstand current delinquencies? And are current delinquencies a sign that robust consumer credit performance is under threat??

Our View

Reversion to Pre-Pandemic Ranges with Subprime Cohorts Underperforming

According to the NY Fed’s fourth quarter 2023 Household Debt and Credit Report, total consumer delinquencies are firmly below pre-pandemic levels and orders of magnitude below GFC-era highs. Performance is anchored by mortgages (72% of total consumer debt) where delinquencies remain at near 20-year lows, and by student loans (9% of total consumer debt) subject to moratoriums. In autos and credit cards (6% and 9% of consumer debt respectively) delinquencies have increased from stimulus-supported lows. However, versus pre-pandemic levels they are either unchanged to marginally higher (credit cards) or firmly lower (autos).?

Recent delinquency increases have been driven primarily by subprime and younger cohorts, often characterized by small-balances in credit cards and used-vehicles in autos. This is pronounced in subprime auto loans where deep-subprime lending volumes grew aggressively in 2021-22 to stimulus-supported used-car buyers (and has distorted comparisons of aggregate delinquencies between post and pre-pandemic timeframes). We believe these borrower cohorts’ credit performance has been more adversely impacted by inflation and note a higher likelihood to be renters exposed to rising rents versus homeowners benefitting from generationally low mortgage rates.?

In aggregate, we remain constructive on consumer credit. The ratio of total financial liabilities to personal disposable income is at a record-low level dating back to 1980, driven by low unemployment and wage growth in excess of inflation. Robust housing values and low-cost, low-LTV mortgage debt further anchors the consumer as 65% of Americans are homeowners, with an average LTV of 43% (plus a record 39% of homeowners have no mortgage) and an approximately 4% average mortgage rate (and 80% of mortgages below 5%). Overall, only 9% of consumer debt is floating (credit cards), and inflation-adjusted credit card debt is at pre-pandemic levels and materially below GFC highs. We retain our view that the consumer is broadly well positioned for continued resilient credit performance.?

Structural Considerations

Post-GFC, transaction structures are often developed using stress-case scenarios for delinquencies and losses that exceed current levels. However, for different rated and unrated attachment points, credit support varies by seniority in the capital stack, and specific positions may experience material underperformance, with rating downgrades and mark-to-market volatility in public markets or loss mitigation workouts in private markets. This places a premium on modeling appropriate collateral loss curves relative to structural credit support to seek appropriate investments.?

Looking forward, we expect to track various indicators of consumer stress and their potential impact on investment performance. First, current delinquency performance may worsen if unemployment broadly increased from current levels. Second, transition rates to 90+ day delinquency have risen, notably for credit cards, signaling borrowers’ reduced ability to cure. Third, a record level of absolute credit card balances may reflect building stress. Finally, the slow burn in ending the student loan moratorium could eventually yield unintended consequences. In the event of increased consumer stress, we note the importance of analyzing how different consumer cohorts may choose to prioritize different payment obligations.?

Market Pricing

In private asset-based finance we continue to see demand for capital from specialty finance companies across consumer and residential sectors. The ongoing reduction in bank lending creates what we believe are attractive risk-reward opportunities for sophisticated private ABF lenders to pick-up yield versus public markets and negotiate bespoke and often superior structural credit support features. In this regard, ABF is largely following the de-banking themes that have driven corporate private credit.?

Public market credit card and auto ABS have experienced material spread tightening YTD but remain cheap to corporates. For example, the subprime auto BBB and BB basis to ICE BBB and high yield corporate indices is still trading in approximately the 75th to 85th percentile of all observations since 2013 (100% being cheapest). We continue to view consumer credit as broadly offering attractive relative value.?

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