The economy is expected to expand in 2018, with projections for stock market performance clocking in at 8% basis Goldman Sachs. But not all is well – a Moody’s report notes that specific asset sectors are struggling, particularly when it comes to car loan quality worsening.
As wage growth is non-existent in some job categories, loan quality becomes a challenge
Moody’s anticipates that US GDP growth will strengthen slightly to 2.3% in 2018 from 2.2% in 2017, with unemployment also continuing to move lower to 4.0% from 4.4%. Despite this, some pockets of borrowers are experiencing strain despite the strong stock market, and this is occurring in the loan market.
“As a result, collateral performance will likely weaken somewhat in several categories of consumer ABS unless wage growth improves more significantly,” a Moody’s report notes. Expect weakness in auto, student and personal loans, as well as credit card balances and mobile phone plans, the December 13 report noted.
“Although the likely continuation of the US economic expansion for a ninth year will offer support for the collateral performance of consumer asset-backed securities (ABS) in 2018, some pockets of borrowers have been experiencing growing financial strains while underwriting in many consumer lending categories has loosened,” the report said, pointing to not just income inequality but a point at which it might hurt investors. “At the same time, many Americans are grappling with higher expenses on a number of fronts that are lessening the benefits of declines in debt payments to generally low levels relative to incomes.”
Specifically, wage growth “has trailed historical levels” ever since the financial crisis, with specific categories of workers experiencing no wage growth at all.
Auto loan quality is worst, but pockets of "challenged" loans exist across the board
In an economic environment where wage growth is stagnant for certain economic strata, leveraged auto loans are one example as to where issues of stress exist.
As auto sales and used vehicle prices are both declining, “the performance of outstanding collateral will remain challenged,” Moody’s noted. The report pointed to a circular paradigm where sales are slipping, with loan quality following in hopes to boost sales:
Auto loan ABS issuers will likely securitize pools with attributes broadly similar overall to those in the pools backing their 2017 securitizations, even as a further decline in US auto sales pressures lenders to loosen underwriting to support volumes. We project sales will slip another 0.6% after an estimated 3.6% drop in 2017, following eight consecutive years of annual increases.
As a result of this impetus to generate sales, standards are slipping:
In a continuation of the accommodative financing environment, as borrowers and lenders seek to keep monthly payments affordable amid higher new vehicle prices and widespread negative equity on trade-ins that boosts loan amounts, LTVs and terms on newly securitized loans will likely increase somewhat further. Meanwhile, the share of longer-term loans in new deals could rise more if banks increase their share of issuance, because banks tend to originate more longer-term loans to compete with subventions and other incentives that captive finance companies can offer. At the same time, automakers' efforts to proactively manage production volumes should somewhat lessen pressure on lenders to loosen underwriting. In addition, banks pulling back on originations, particularly in the subprime market, has allowed other lenders to pick up volume, partially explaining a mild increase in the credit scores of subprime loans securitized by certain sponsors. However, the market remains and will remain highly competitive.
Auto loans appear to be on the front-lines of credit issues. Household debt, for instance, has increased to $13 trillion, with a significant part of that increase in auto loans. Sub-prime auto loans, in particular, are showing signs of weakness.
But that situation isn't happening across the board to the same degree.
While auto loans are weakening, credit-card-based loan security products are expected to remain mostly consistent with a few pockets of weakness. “Although account performance will weaken somewhat, charge-offs and delinquencies will remain low,” the report noted.
Student loan credit quality is not expected to change while personal loans “will likely have similar to slightly worse collateral quality in comparison with 2017 deals,” the report stated. “Asset performance of outstanding online lender ABS will weaken somewhat.”
When looking at investment in asset-backed securities, the originator makes a difference. ABS backed by loans from online lenders such as SoFi, Lending Club Corporation, Prosper Marketplace Inc. and Marlette Funding have correlated with “prime credit quality.” But that is not the case across the board. “However, a few ABS backed by loans from some of these lenders have focused on lower-quality borrowers.”