Most consumer ABS structures can withstand expected weakness
On balance, consumers are returning to a more normal state, which will likely be characterized by slowing savings rate, stronger demand for loans, and normalizing delinquencies. However, balance sheets (especially for upper-end consumers) are robust, which will continue to support the economy. Some of the persistent inflation pressures will be offset by wage gains in a tight labor market but I expect pressures to increase as removing some of the tightness of the labor market remains a focus of the Fed. Credit contraction should impact the consumer in a higher unemployment scenario, but the pace at which this unfolds will determine the amount of stress on the consumer and therefore the economy (the slower the better).
Across the consumer asset-backed securities (ABS) universe, I think the most compelling investment opportunities are at the top of the capital structure. In my view, investors should consider focusing on collateral for which priority of payment is high, including handsets, autos, and general-purpose credit cards.
I believe the bottom of the capital structure is only attractive for select issuers where structural enhancements have been put in place in response to consumer performance deterioration and underwriting has materially improved from late 2021 to early 2022. Sponsor risk is elevated during credit-tightening environments, so it is critical to focus on strong sponsors with skin in the game. For example, I think it is prudent to avoid consumer loans, revolvers, or lower-tier sponsors that are not prepared to manage through a recession.