Rate cut seen as positive for consumer ABS
Last week’s interest rate cut was seen as a positive for consumer ABS fundamentals, as lower rates will increase the affordability of debt and help lenders maintain origination volumes without relaxing underwriting standards, according to investors and analysts.
Against a potentially volatile backdrop of trade wars and uncertainty over future rate cuts, consumer ABS is well positioned due to the strength of consumer credit fundamentals and lower issuance volume this year, said market watchers.
The unemployment rate remained at 3.7% in July according to the Department of Labor on Friday, close to the 50-year low of 3.6% seen in May, while wage growth rose by 3.2%.
These trends are expected to drive healthy performance in bonds backed by consumer debt, according to analysts.
“To date consumers have not felt direct pain from tariffs and remain healthy as reflected in the very positive 2Q19 earning beats from the top consumer lenders, even as recession risks are looming,” said JP Morgan analysts in a report published Friday.
“ABS offers attractive structural protections and relatively better spread stability against these uncertainties,” they said.
Last week’s interest rate cut should help lessen the strain on debt affordability for consumer borrowers and also help originators maintain their loan volumes without compromising on credit or underwriting credit quality, said Moody’s analysts in a report last week.
This should all be positive for consumer ABS performance for the time being.
“The US consumer remains very healthy. That’s the biggest driver of ABS underlying performance,” said Eric Souza, senior portfolio manager at Silicon Valley Bank. “We’re seeing incomes continue to do well and jobless claims continue to be near 50 year lows. Overall, from a credit fundamentals standpoint this bodes very well.”
New deal volumes are also down on last year’s figures, which helps to create a positive technical support for the market. According to IFR data, at the end of last week US$145.182bn of new ABS had been sold, compared with US$162.005bn in the same period last year.
Expectations of further rate cuts may prompt investors to target longer duration bonds, compared with last year, according to Souza.
“In 2018 you wanted shorter maturities and to be defensive on duration, to have the opportunity to reinvest at higher yield,” he said. “The theme for 2019 is lower rates going forward. In that environment, you want to look to add duration and extend maturities.”
Spreads may come under pressure as the escalation of US-China trade disputes pushes credit spreads generally wider, but consumer ABS should still outperform higher yielding sectors because consumers are on a more stronger footing than commercial sectors, according to Bank of America Merrill Lynch analysts.
Sectors such as aircraft, container and railcar ABS may be more heavily impacted by trade tensions and concerns over the global economy, they said.