Record asset-backed issuance meets tight spreads. Here's why security selection matters as the consumer bifurcates.
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Hello, welcome back to the latest edition of the Weekly Fix. I am Teri Savage, a Senior Trader for RBC BlueBay focusing on the securitized sectors. The asset-backed market has started off the second half of the year with a bang. Last week, we saw a flurry of primary issuance ranging from more vanilla autos, credit cards, and equipment to more esoteric deals with home improvement and aircraft collateral backing the deals. The market has been absorbing the supply well, and we've seen more secondary selling to make room for the primary supply.
Gross issuance in the asset-backed securities (ABS) market is forecasted to hit record levels this year. Supply in the ABS market is being driven by funding costs, diversification needs, consumer debt growth, and new sectors entering the market.
Despite the hefty supply levels, ABS spreads are generally sitting at year-to-date tights across most ABS subsectors. We saw spreads widen earlier in the year due to geopolitical uncertainty, but most ABS subsectors are now tighter than the end of last year. Here are the 3 key takeaways on the backdrop for ABS:
1. Demand. Demand has been supporting valuations, the market's ability to absorb heavier supply. Strong bond inflows and insurance company demand are noteworthy. Given expectations of higher for longer on interest rates, investors are favoring shorter duration assets with resilient fundamentals, which should limit potential for spread widening. Security selection becomes more critical at these tighter valuations and the wiggle room for error has narrowed.
2. Consumer. Overall, the consumer is holding up well and looking healthy, but it's bifurcated, with more stress concentrated in subprime borrowers with lower-credit and higher LTV profiles. Early-stage delinquencies remain well below pre-pandemic levels and are supported by resilient employment. However, delinquencies are expected to gradually rise from current levels, and higher interest rates will place more pressure on the consumer.
3. Risks in the ABS market center around geopolitical, technical, and fundamental. Geopolitical tensions remain in the Middle East, and growing tensions there are a risk to the overall backdrop for the markets. Technical risks center around valuations, with spreads historically stretched, the potential for spread widening has increased. And lastly, fundamental risk. If we were to see strain on the consumer and credit deterioration, this has the potential to leak into borrower and lending sectors and possibly cause weakening in collateral performance.
To wrap up, the ABS market is on pace for a record year of issuance. Spreads are near historical tights and investors are engaged and looking for spread compression opportunities. Strong structural demand has supported spreads so far this year, despite continued Middle East tensions and uncertainty. Given the bifurcated consumer, security selection, particularly relating to credit tiering, is increasingly important for ABS investors.
Thank you for your attention and good luck navigating the markets ahead!
Key takeaways
Asset-backed securities (ABS) issuance is on pace for a record year, driven by funding costs, diversification needs, consumer debt growth, and new sectors entering the market – yet spreads sit at year-to-date tights across most ABS subsectors.
The consumer's holding up, but it's bifurcated. Stress is concentrated in subprime borrowers. Early-stage delinquencies are below pre-pandemic levels, but they're expected to rise gradually as higher rates put more pressure on consumers.
With spreads stretched, security selection and credit tiering matter more than ever. The wiggle room for error has narrowed, and risks span geopolitical, technical, and fundamental factors.