There's an opportunity to find solid yield in asset-backed securities, even as headwinds emerge

Published Wed, Sep 4 20242:42 PM EDT

Headwinds have been emerging in the consumer space, which may have some investors wondering about the impact on asset-backed securities. The securitized products, known as ABS, are backed by a pool of income-generating assets such as auto loans or credit card receivables. Investors have been turning to them for their attractive yields. The ICE BofA U.S. Fixed Rate Asset Backed Securities Index, which tracks the performance of U.S. investment grade asset-backed securities, currently has an effective yield of 5.12%, per FactSet. Consumers are still spending money, with retail sales in July increasing 1% from the previous month, according to Commerce Department numbers that are adjusted for seasonality but not inflation. Yet they are dialing back on borrowing and are concerned about falling behind on payments, Piper Sandler said in an Aug. 19 note. "The combination of 20+% rates and monster outstanding balances finally has consumers pulling back on borrowing, with revolving credit down in 2 of the last 3 reported months," the team, lead by chief global economist Nancy Lazar, wrote. Revolving credit refers to credit card debt. Still, the Federal Reserve Bank of New York reported that in the second quarter, credit card balances increased by $27 trillion during the second quarter to $1.14 trillion — a 5.8% increase from a year prior. Meanwhile, 30 day-plus delinquencies have moved above pre-Covid levels for both credit cards and auto loans, Piper Sandler noted. While auto loan delinquencies are still concentrated in subprime, prime delinquencies are also above pre-Covid levels, the firm said. "Delinquencies will rise further as (inflation and) corporate revenues slow, loosening the labor market further, cooling compensation gains," the team wrote. A separate analysis by BTIG showed the consumer remains under pressure. The savings rate fell by 22 basis points to 8.2%, the lowest level since June 2022, the firm said in a note Friday. One basis point equals one-hundredth of a percentage point. Yet the story is a bit more nuanced, said John Kerschner, head of U.S. securitized products and portfolio manager for Janus Henderson. One of the funds he oversees is the Securitized Income ETF (JSI), which has about 41% of its portfolio in ABS, as of Tuesday. The ETF has a 30-day SEC yield of 6.82%. JSI YTD mountain Janus Henderson Securitized Income ETF The rise in delinquencies is not unexpected since they were at record lows during Covid and the economy has slowed a bit, he noted. Still, investors in the space are more narrowly focused than the overall consumer data, Kerschner said. For instance, auto loans now total $1.63 trillion, according to the New York Fed. However, the ABS market for auto loans is about $250 billion, he pointed out. "Out of that $250 billion, about 60%, 65% is Triple-A rated, which, unless you are talking about … incredibly dire situations, are going to be just fine," he said. "The subset of things that are of concern to investors is really, really small." That said, Kerschner and his team do their due diligence, making sure the underwriting is robust, the credit models are well calibrated and that their funding is sound. Right now, the real issue is tight credit spreads, not delinquencies, he said. Within ABS, he likes the equipment sector. "It's a little more niche," he said. "Not as well known as some of the issuers, but you can still find some good value there." He also likes credit-linked notes that are issued by banks. It's a new sector, also not well known, and trading very cheap, he said. One of JSI's top holdings is an auto credit-linked note from Santander. Nick Travaglino, head of the securitized sector team at Nuveen, also believes there are still opportunities to be had in the ABS market. The firm's Strategic Income Fund , which Travaglino manages, has 14% allocated to asset-backed securities — its second largest holding. The fund has a 6.48% 30-day SEC yield. "You can pick up additional yield with a high-quality pool of assets," he said. "Furthermore, the ABS market, generally speaking, is poised to perform quite well, even as the Fed starts cutting rates." That's because typically ABS issues are around five-year maturities, he said. Within the ABS market there are also opportunities in consumer-focused papers, as well as unsecured consumer loans that get securitized, he noted. "The level of credit quality in the pool of assets that have been securitized — it is significantly better than what that pool of assets looked like two years ago," Travaglino said. "As they are consolidating groups of loans … the lower credit quality borrow is not being included in the pool." Shannon Saccocia, chief investment officer of NB Private Wealth, still believes there is a place for ABS in the portfolio, although she is being thoughtful in her positioning. Her view since the start of the year has been that any defaults across fixed income would be idiosyncratic. So far, the consumer has been thoughtful and discerning, she said. When it comes down to having to choose which bills to pay, they'll likely be delinquent on the more discretionary bills — such as cell phones — rather than their car, she said. "You do need to continue to look at corporates [and] Treasurys, but also securitized products because if it isn't going to be this broad default cycle, there are going to be opportunities in securitized, already trading at a wider spread and requiring a discerning eye," Saccocia said. Within the broader securitized market, her preferred position is mortgage-backed securities.