Investors fear more big hits for bonds backed by US consumer loans

Investors have beaten a retreat from the $1tn US market for bonds backed by car loans, credit cards and other consumer lending, as a sharp jump in unemployment threatens borrowers’ ability to pay them back.

So far this year, yields on low-rated bonds backed by car loans in the US have quadrupled to 8 percentage points over benchmark rates, according to data from JPMorgan, implying heavy selling pressure. Meanwhile, the flow of new bond deals backed by consumer loans has dwindled.

Specialists in the asset-backed securities market say weakness is likely to intensify as job losses stack up.

“I think one thing people are not paying enough attention to is that really bad jobless number,” said Jason Merrill, a portfolio manager at Penn Mutual Asset Management. The number of Americans claiming unemployment benefits shot up by 6.65m last week — more than double the previous week’s 3.3m.

“If we start seeing massive unemployment that will have a very significant implication for consumer credit,” he said.

Previous crises show that people struggle to pay back debts when unemployment rises. During the last financial crisis, credit card defaults coincided with the peak in initial jobless claims in March 2009. Auto loan defaults peaked slightly earlier, in December 2008, JPMorgan notes.

Line chart of defaults rate (per cent) showing Consumer ABS defaults rise with unemployment

Some parts of the US ABS market have proven more resilient. Yields on bonds backed by the highest-rated fixed-rate credit card repayments, maturing in three years, jumped from 0.26 percentage points above their benchmark earlier this year to a peak of 2 percentage points in March. But spreads have since slipped back to 0.8 percentage points, according to JPMorgan.

On lower-rated triple B debt, yield spreads have halved to 1.6 percentage points amid a broad rebound in markets following a host of extraordinary support measures from the US Federal Reserve.

“There is definitely concern because consumer metrics are very much correlated with the labour market. If people don’t have jobs then they can pay their bills,” said Amy Sze, an analyst at JPMorgan.

One comfort for bondholders is that deals can often withstand a high rate of consumer defaults before inflicting losses on investors. Triple B-rated subprime auto ABS, for example, can experience about 15 per cent of losses on the underlying loans before bondholders start to take a hit, said Ms Sze. For triple A rated credit cards, the figure is about 20 per cent.

But rising delinquency rates are unlikely to show up for several months, suggesting that ABS prices in the market may remain under pressure. Data for March, for example, to be reported in mid-April, will probably show a rosier picture than reality, given that struggling borrowers have been granted payment extensions.

“We just don’t know,” said Jennifer Thomas, an analyst at investment house Loomis Sayles. “You haven’t seen an issuer put out an absolutely horrible number yet, which is what drives the ABS market.”

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