What could US tariffs mean for US securitised?

Despite the recent pause in tariffs, we believe that the probability of a mild US recession remains high. For more detail on the US economic outlook, please read our Head of Economics’ latest thoughts.

A resilient market

It’s worth reinforcing upfront that the US securitised market is deep, liquid and diversified, supported by a broad base of investors and underpinned by decades of structural development. We believe this can help to provide an important buffer against market volatility. Despite recent market headlines, the securitised market continues to function well with liquidity.

Direct tariff impact

We believe the direct impact of tariffs on the US securitised market is low. One area of the market directly affected is container shipping – a type of asset-backed security (ABS). Tariffs can increase the cost of imported goods, which may lead to reduced demand for shipping services.

We have reduced our exposure in this area significantly over the past few months. It is worth noting that shipping containers – how full they are and how much they are used in global trade – tend to stay in steady use even during economic slowdowns, which can help support the value of investments linked to this sector. 

The automotive leasing industry is another area which is impacted by the high tariff rates. Higher import prices and costs for parts can lead to increased vehicle prices and reduced sales. If that is the case, then auto loan recovery rates (i.e. the percentage of a defaulted auto loan that a lender can recover) could increase. This is because the demand for existing vehicles might increase, maintaining their value and making recovery more viable.

In commercial mortgage-backed securitised (CMBS), we believe that industrial and warehouse properties may also benefit in the short term, as demand for inventory storage rises amid supply chain disruptions. 

Indirect tariff impact

Indirectly, several sectors are potentially impacted by the second-order effects of a slowing US economy. For example, slowing GDP growth and higher unemployment may lead to higher delinquency rates across consumer ABS – particularly in credit cards, personal loans, and auto loans. 

Tourism rates are reported to be falling which may feed its way through to hotel revenues and in turn into asset valuations for hotel CMBS. Higher input costs may also impact retail sellers which in turn may feed its way through to CMBS asset valuations. Similarly, inflation and the prospect of higher for longer US rates could also challenge asset pricing across sectors.

If tariffs contribute to a prolonged downturn, we may see higher loss rates in lower credit segments such as subprime auto and personal loans as well as general deterioration in consumer credit scores. A key driver of consumer ABS performance is the consumer credit score, known as the FICO score – a widely used credit scoring system that assesses a borrower’s creditworthiness based on factors such as payment history, debt levels and credit age.

Lower FICO scores indicate increased credit risk, which can lead to higher delinquencies and weaker performance in securitised products backed by consumer loans. Retail weakness could also spill into retail CMBS (albeit with a lag), while hospitality franchise and whole business ABS may face pressure. 

Portfolio implications

In our client portfolios, we have made some changes to seek to take advantage of recent price movements. Specifically, we have been increasing exposure to US government-backed mortgage securities, which we believe offer better value right now.

At the same time, we have reduced our exposure to fixed-rate AAA rated auto loans and AAA/AA rated collateralised loan obligations (CLOs). We expect the US government-backed mortgage securities to hold up better in the short term and to perform more strongly than other areas in the securitised market, like CLOs, if the US economy slows. 

We have also aimed to reduce the sensitivity of some portfolios to market volatility and increase the overall credit quality. This has been achieved by cutting commercial ABS exposure (shipping containers for example with direct tariff impacts), reducing exposure to data centres and whole business franchises, lower quality auto fleet lease financing and CLOs. We have typically recycled this risk into US government-backed mortgage securities, which we believe have the potential to hold up better should we experience a return to a risk-off environment.

The macro environment remains fluid, particularly with regard to tariff-related uncertainty, and we recognise that risks remain, especially if economic conditions deteriorate further. We believe our focus on high-quality assets and active risk management leaves our client portfolios well equipped to handle a range of market conditions. 

As bondholders in the senior tranches, we aim to benefit from credit enhancement mechanisms such as subordination and overcollateralisation. These features are designed to insulate senior tranche investors from potential defaults.

 

Key risks

The value of an investment and any income taken from it is not guaranteed and can go down as well as up, and the investor may get back less than the original amount invested. Assumptions, opinions, and estimates are provided for illustrative purposes only. There is no guarantee that any forecasts made will come to pass. For illustrative purposes only. Reference to a particular security is on a historic basis and does not mean that the security is currently held or will be held within an L&G portfolio. The above information does not constitute a recommendation to buy or sell any security. It should be noted that diversification is no guarantee against a loss in a declining market.