Mortgage & Structured Finance Outlook: Where We See the Value

1. How have consumers weathered high inflation so far? What is your view on consumer asset-backed securities (ABS) going forward?

In our view, the consumer has held up pretty well. Consumer fundamentals appear to have largely reverted back to pre-COVID-19 levels after strong performance from 2020 to early 2022. However, a divergence in loan performance between higher- and lower-quality borrowers has recently become apparent in our auto loan delinquency surveillance. The performance deterioration among subprime and near-prime borrowers suggests a combination of inflation pressures and waning pandemic savings has begun to negatively impact consumer balance sheets. Though wage growth remains strong among these lower-quality borrowers, it is starting to fade.

Looking ahead, we think that rising costs of food, rent, energy and childcare will continue to be a major concern for these borrowers. In addition, further stress on consumers could come if the government starts requiring federal student loan borrowers to resume their loan payments. Lenders have tightened underwriting standards in light of the economic pressure on consumers. We believe this tightening of the credit box could hinder consumers’ ability to lever up, helping them maintain stable balance sheets.

Our analysis indicates the investment grade portion of the capital stack would be well supported if we experience a steep rise in the unemployment rate. We favor investment grade classes from top-tier issuers because we believe they offer the most downside protection due to their strong servicing, high levels of credit support and amortizing delevering structures.

2. Real estate markets are contending with a surge in mortgage rates and rising recession risks. How has that affected commercial and residential mortgage-backed securities (CMBS & RMBS)? In which parts of the market do you currently see the best value in 2023?