Amid the economic recovery from the COVID-19 pandemic and the reopening of the U.S. economy, consumer debt has taken a surprising turn by outperforming better-than-expected credit performance. However, market watchers say the conditions that made possible better consumer credit, particularly consumer installment credit, are unlikely to reappear in the next economic downturn.
As consumers benefited from major programs like student loans and mortgage payment forbearance programs, they took advantage of the godsend to pay off debts and build savings.
“An unprecedented level of federal relief such as improved unemployment benefits, direct stimulus payments, and extensive deferral programs have supported credit performance in consumer credit markets during the pandemic,” said Elana Lipchak, an ABS strategist on Bank of America’s global research team, in An E- Mail reply.
Asset-backed trusts continue to see the benefits of the way consumers have allocated their stimulus and aid payments. Consumer credit ABS, like other consumer-oriented bonds, have seen better-than-expected credit performance results even in recent months, according to Bank of America Securities.
Part of this performance is owed to the marketplace loan segment, which according to BofA made up just over a third (33%) of the total ABS volume for consumer loans in the year to date.
The net loss rate for ABS marketplace loans was 4.4% in May 2021, slightly above the low of 4.3% in October 2020 according to the latest available data.
In the year before the pandemic, the net loss margin was 6.0% to 8.5%, still below the 12% it hit in 2016 and the 2017 market credit ABS pipeline with new deals to start with The challenging economic environment in 2020 reduced the demand for credit. In addition, marketplace lenders diversified their funding sources by taking over banks or issuing pass-through securities. Regarding the latter, marketplace loan structured finance sponsors have spent approximately $ 7.6 billion in pass-through certificates.
Despite all the support, the strong unemployment rates, unlike previous recessions, did not lead to higher defaults. While the unemployment rate reached 14.7% in April 2020, a shocking increase from 3.5% in February 2020, according to data from the Bureau of Labor Statistics.
The economic indicators have improved significantly for a year. The unemployment rate rose to 5.9%, while observers expected it to decline to 5.6%. The shift coincided with the economy adding 850,000 jobs to the payroll in June, beating the estimate of 720,000 pay increases.
The state of the economy looks promising now, but Bank of America’s concern is the next recession, Lipchak said.
“The government cannot take such extraordinary measures,” she said. Should that happen, Lipchak said, the bank would expect the normal link between rising unemployment and higher defaults and defaults to take shape.
In terms of a pool of collateral for asset securitization, personal installment loans generally rank at the bottom of the payment hierarchy after auto loans, mortgages and rentals, and credit cards.
“This should result in weaker credit performance,” said Lipchak. The short-term picture looks more positive. “The improving employment situation, ongoing incentives and savings as well as stricter underwriting standards should have a supportive effect until the rest of the year 2021.”
Now what is a real lender?
Recently, President Joseph Biden signed a resolution repealing an ordinance of the auditor’s office that stipulated when a national bank or federal savings bank would make a loan and referred to as the so-called true lender.
The rule, only passed in October last year, stipulated that a bank is a real lender if it is named as the lender in the loan agreement and finances the loan at the time it is granted. Even if a bank is named as the lender in the loan agreement at the time of granting and another bank is financing the loan, the bank named as the lender in the agreement will finance the loan, Lipchak said.
As a true lender, the bank therefore retains the compliance obligations associated with financing.
But President Biden’s approval of the repeal brings uncertainty into the asset class that would increase legal uncertainty, discourage partnerships, and discourage innovations that emerge from such partnerships, Lipchak said.