How Aid to U.S. Consumers Could Benefit the ABS Market | Lord Abbett
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Fixed-Income Insights

Provisions in the CARES Act could cushion the financial blow to U.S. households from rising joblessness—potentially lending support to consumer-focused asset-backed securities.

 

In Brief

  • While the final impact of COVID-19 on U.S. employment is yet to be known, it is clear in the early going that the financial disruption for consumers will be material and of indeterminate duration.
  • Previous periods of consumer stress may be somewhat instructive in analyzing potential economic harm, but this crisis has as many if not more differences than similarities with past crises.
  • Policymakers have recognized this, and have moved with remarkable speed to attempt to soften the blow to consumers and businesses
  • We believe that high quality consumer focused asset backed securities (ABS) remain an area of opportunity despite the challenges of the current environment.

 

COVID-19 presents a meaningful challenge to the financial well-being of U.S. consumers, and thus represents a potential major threat to financial instruments dependent on overall consumer health. Consumer asset-backed securities (ABS), the largest sectors of which include auto loans and credit card receivables, derive their cash flows from loans made to individuals, and thus are exposed to risks to personal income.

Historically, even in periods of high unemployment, high-quality consumer ABS have fared rather well. Even during the global financial crisis (GFC) and its aftermath, defaults in ABS were relatively low, if not non-existent.

 

Chart 1. Historically, ABS Defaults Have Been Extremely Rare
Default rates of asset- backed securities by credit-rating tier, 1986-2018

Source: S&P Global Ratings. Data based on a historical study of defaults by S&P Global; most recent data available. Subject to change based on changes in the market.
For illustrative purposes only and does not represent any specific portfolio managed by Lord Abbett or any particular investment.

 

While the historical performance of ABS, particularly during the GFC, may offer some comfort, it could very well be that “it’s different this time.” Unemployment peaked at 10% during the GFC; COVID-19 may push unemployment higher than that, at least in the near term, as social distancing and government-mandated business closures push individuals into unemployment.

Fortunately, policymakers have recognized that this time around, the economic brunt will be felt directly by consumers. U.S. legislators moved the CARES Act through both houses of Congress with remarkable speed. While it contains many provisions to aid both businesses and individuals, one of the features of the bill with the potential for the greatest near-term impact, in our view, is the extension of unemployment benefits and an additional $600 a week to jobless-benefit claimants for the next four months, on top of whatever state programs pay. This provision of the bill extends both to the self-employed and independent contractors as well as those working in the “gig” economy. 

Based on data from the U.S. Bureau of Labor Statistics, average weekly earnings in the United States for employed persons are about $975. When the $600 special supplement to unemployment is combined with the normal unemployment insurance of $487, the total represents an increase versus the average weekly wage of about 11%. This is an extraordinary boost and should go quite far to insulate consumer budgets from the impact of an economic slowdown.

 

While consumer ABS, by their nature, have many features that are attractive to investors and potentially serve to insulate the asset class from the negative impact of economic downturns, we believe the CARES Act, though at this time limited in its duration, will go a long way to protecting the financial well-being of consumers and consequently, the asset-backed securities that rely on their overall financial health.

 

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