As a result of these trends, consumer defaults are on the rise and are likely to continue as economic growth slows. However, our Global Macro & Asset Allocation team expects subprime borrowers to account for a disproportionate number of defaults.
Where are the investment opportunities for ABF in consumer finance?
As the name suggests, asset-based financial investments are secured by collateral. In the consumer world, this includes mortgages and car loans secured by real estate.
The dichotomy among consumers led us to focus on opportunities where the end borrower has a high, stable income and a high credit score. In our experience, these borrowers are not only strategically reluctant to default, but now have more resources to avoid default than ever before. We also give priority to loans that have a high priority for the borrower. A good example is a car loan. Cars have become an essential means of transportation in many markets outside of large cities, but prices have soared since the pandemic. For most car owners, the cost of paying a car loan is likely to be lower than the cost of purchasing a new car or the consequences of losing reliable transportation.
Here are some examples of recent opportunities in the consumer space that seem attractive.
• Home Improvement Loans: We recently invested in a platform that provides home improvement loans to homeowners with the best credit scores (average FICO score of 780). As mortgage rates have risen significantly, we know that people with existing low-interest mortgages are more likely to stay in their homes than look for a new mortgage. We believe this trend will support home renovations in the coming years.
• Recreational Vehicles: RVs are the ultimate discretionary purchase, and the fact is that people who buy RVs tend to have very good credit scores. We recently purchased his RV loan portfolio from a bank. At that bank, 80% of borrowers are homeowners with deep credit histories, and the group's weighted average FICO score was 773, compared to the U.S. average of 715 in 2023, according to Experian. Title, lien, and insurance requirements are similar to auto loans, as are recovery procedures if the owner fails to pay.
• Solar panel loans: These loans tend to be offered to homeowners and include an incentive to provide essential services (electricity) and suspend payments. For example, in one recent transaction, the average FICO score for the borrower was 769. Customers who take out a loan to install solar panels won't pay as much over the life of the loan because of the savings on their electricity bills. Ultimately, utility rates should be lowered permanently. Stopping payments does not mean your utility bills will go away. It simply means that homeowners have to pay utility bills for the energy they use.
As banks withdraw from consumer lending, investment opportunities for consumers with high credit ratings are increasing. Following the collapse of local U.S. banks in early 2023, banks are considering reducing their long-term loan portfolios, including some consumer loans.
While this area is certainly not the only area with attractive opportunities in this market, it is the area that we feel is the most misunderstood. We believe that careful selection of borrowers and assets creates very attractive opportunities in the consumer space.
