Resilient consumers put holiday bow on credit card ABS
Robust spending and low delinquencies bode well for yields.
In this environment of historically low interest rates and rate uncertainty, asset-backed securities (ABS) have proven to be a reliable source of relatively attractive yield for income-oriented investors. Short-duration strategies such as ultrashorts have been particular beneficiaries. Now, amid signs the economy is re-accelerating with rates more likely to rise than fall, a once dominant component of the structured credit universe appears set to pick up.
Healthy household balance sheets, increasing employment and rising incomes are creating tailwinds for credit card ABS, which accounted for more than a fifth of ABS issuance as recently as 2017 but represents just 5% of new issuance this year. Surveys indicate consumers expect to spend freely this holiday season, and other consumer-focused categories of the securitized market such as auto loans and leases, equipment leases and insurance premium receivables are going strong, too.
A credit card portfolio generates income in various ways, including Annual Percentage Rate charges, annual fees, late-payment fees and over-limit fees. Another source of portfolio yield can be recoveries on charge-offs and interchange income, which comes from fees that are paid to issuing banks to cover transaction processing costs and to compensate for credit risk involved in funding receivables.
Supported by shifting consumer attitudes toward debt, spending preferences and significant fiscal stimulus packages, credit card ABS withstood the challenges presented by the Covid-19 pandemic. From the onset of lockdowns and well into 2021, consumers pulled back on non-essential spending, especially travel, leisure and other services. In turn, they used their savings and stimulus dollars to pay down debt, which further strengthened household balance sheets. This willingness to repay debt can be seen in the monthly payment rates of credit card trusts, a measure of how quickly a card borrower repays their outstanding balance. In the U.S., card payment rates were typically around 30% pre-Covid but have since risen to nearly 40%. Canadian credit card payment rates are even higher, up from roughly 45% pre-Covid to nearly 60%.
Both prime and retail credit card ABS has continued to outperform pre-Covid levels, with delinquencies in some cases reaching record lows, according to data through the year’s first nine months from credit rating agency Fitch. Fitch’s U.S. Prime Credit Card Charge-off Index (primarily comprised of general-purpose portfolios originated by institutions such as Bank of America, Citibank, Chase and Discover) remains at an all-time low of 2.00%, down from 2.96% in September 2020 and 3.00% in September 2019, when the unemployment rate was 3.7% versus 4.8% this September. Meanwhile, the agency’s Canadian Credit Card Charge-off Index (comprised of credit card receivables originated by Canada’s largest banking institutions) is at 1.66%, significantly below September 2020’s 2.21% and September 2019’s 2.89%. Bottom line, we don’t consider the U.S. or Canadian consumers overextended, a view reinforced by the performance of our ABS holdings.
Looking ahead, we expect household fundamentals will likely remain in good shape in a strong economy supported by continuing employment and wage increases. Both factors should be supportive of future credit card ABS performance. However, just as we regularly monitor ABS structures and collateral quality, we will continually keep an eye on consumer data and leading indicators for any potential impact on the securities in which we invest.