Consumer asset-backed finance refers to investments secured by future income streams related to consumer financial obligations (loans and receivables) which have been bundled into diversified collateral pools.
Common types of consumer asset-backed securities include:
Auto loans and leases
Credit card receivables
Student loans
Personal loans
Lease-to-own agreements
The underlying principle is that the cash flows from these consumer debts provide a steady stream of income to investors, while the assets themselves (e.g., cars, homes) serve as hard collateral with inherent liquidation value reducing the risk of the investment.
The landscape of private consumer asset-backed finance was profoundly reshaped by the aftermath of the 2008 Global Financial Crisis (GFC). Post-GFC regulatory changes, designed to prevent a repeat of the subprime mortgage crisis, forced traditional banks to scale back their involvement in certain lending sectors and their risk retention parameters. This regulatory shift created opportunities for alternative lenders and investors to fill the gap, driving interest from major financial institutions.
In this post-GFC environment, private consumer asset-backed finance became increasingly attractive among investors and asset managers due to its distinct combination of steady cash flows from consumer payments, coupled with the relative security of tangible collateral.
The resilience of the consumer sector, demonstrated through various economic cycles, has reinforced its importance as both a diversification tool and a barometer of overall economic health. For financial institutions, these qualities provide valuable exposure to a broad cross-section of the economy.
The American consumer continues to be the bedrock of economic growth, demonstrating remarkable resilience despite persistent challenges. Consumer spending, fueling nearly 68% of the nation’s GDP in Q1 20241, remains robust in the face of inflation and higher interest rates.
This resilience is bolstered by recent positive trends. US retail sales accelerated in July 2024 by the most since early 20232 and rising equity and property markets have contributed to an increase in overall household net worth, further supporting continued spending.
However, this resilience is not without vulnerabilities. Consumer debt has reached new heights, with total household debt reaching $17.80 trillion according to the Federal Reserve Bank of New York3. While current debt service ratios remain manageable, they are trending upward. The depletion of pandemic-era savings and the resumption of student loan payments add further pressure that requires monitoring.
Looking ahead to the latter half of 2024, consumer confidence is showing modest signs of improvement, with the Conference Board Consumer Confidence Index rising to 100.3 in July, reflecting consumers’ ongoing ability to navigate economic challenges and maintain their crucial role in driving economic activity4.
Perhaps the most significant development for consumers has been the marked moderation in inflation. July 2024 saw the Consumer Price Index (CPI) rise by just 2.9% year-over-year, its lowest annual growth rate since March 20215. This easing of inflationary pressures is expected to provide much-needed relief to household budgets, potentially fueling continued consumer spending and economic activity.
Further bolstering this optimistic outlook is the anticipated normalization of Federal Reserve policy rates, broadly expected by the market in September6. This shift could offer additional support to consumers through improved borrowing conditions.
While challenges undoubtedly persist, we believe the confluence of moderating inflation, steady employment, and consumers’ demonstrated resilience offers grounds for cautious optimism, with the American consumer’s adaptability likely to remain a key driver of economic activity and crucial in shaping the future of the economy.
Sources:
1. Source: U.S. Bureau of Economic Analysis. “Gross Domestic Product, Second Quarter 2024 (Advance Estimate).” Released July 25, 2024
2. Source: U.S. Department of Labor. “Unemployment Insurance Weekly Claims.” Released August 10, 2024.
3. Source: Federal Reserve Bank of New York. “Quarterly Report on Household Debt and Credit.” Released August 6, 2024.
4. Source: The Conference Board. “Consumer Confidence Survey®.” Released July 30, 2024.
5. Board of Governors of the Federal Reserve System (US), Households; Net Worth, Level [BOGZ1FL192090005A], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/BOGZ1FL192090005A, August 26, 2024.
6. U.S. Bureau of Labor Statistics, Consumer Price Index for All Urban Consumers: All Items in U.S. City Average [CPIAUCSL], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/CPIAUCSL, August 21, 2024.
7. CME FedWatch Tool indicates a 93.3% probability of a quarter percentage point reduction in the Federal Reserve’s target range for federal funds by September 2024, with a 6.7% probability of a half percentage point decrease, influenced by a recent consumer price index report showing a decline in inflation.
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