Video transcript

Kathleen Lynch: The pandemic introduced a significant amount stress and volatility into the financial markets, levels we have not seen since the global financial crisis in 2008. In fixed income portfolios, we employ asset-backed securities. Asset-backed securities reduce the overall portfolio interest rate sensitivity. This mitigates the negative impact of increased volatility. Asset-backed securities, commonly referred to as ABS, is a subset of the securitized market.

Auto loans and credit card receivables are the two largest segments in the ABS market. As the underlining consumer makes their monthly debt service payments, those payments flow through to the investor. As such, credit performance in ABS depends in large part on the health of the underlining consumer and their ability and willingness to repay those loans. So, when the pandemic infected our economy, forcing businesses to close their doors and sending their employees home, ABS investors were gauging the impact on the health of the underlining consumer. Fortunately, consumers entered the pandemic-driven recession in a relatively healthy position. However, fiscal stimulus provided under the CARES Act and the American Rescue Plan Act provided additional significant benefits to the consumer.

As a result, household savings rates are at all-time highs and credit metrics, such as delinquency rates and net charge-offs on auto loans and credit card receivables, have continued to improve since the initial shock. It’s clear that fiscal stimulus had a direct positive impact on the health of the consumer and their ability to pay their debts. However, as elevated unemployment persists and consumers spend down their stimulus, risk remains that their ability to make debt payments in the future could be challenging. If consumers are strapped for cash, they will be forced to prioritize their payments, which could impact the credit performance of ABS. The Fed Consumer [Credit] Panel study in March of this year suggests that consumers are almost evenly split between prioritizing auto loans and credit card loans. This is a change from 15 years ago when consumers were 80% more likely to prioritize their auto loan.

So, here we are, a little over a year since the pandemic hit, credit measures in both sectors continue to improve. This suggests that the prioritization of payments has not been significant. However, the health of the consumer remains at elevated risk and will until the pandemic is contained, the economy is fully reopened, and unemployment improves. We continue to find value in ABS; however, we remain vigilant in our due diligence and surveillance to help ensure that our clients are receiving the incremental yield and the diversification that the sector can offers.