N°24-102: The Pricing of Asset-Backed Securities and Households' Pecking Order of Debt

This paper studies the role of households' pecking order of debt in the pricing and rating migration of U.S. consumer debt asset-backed securities (ABS). Our empirical results show that the household's delinquency on mortgage and auto loan increases spreads of ABS using these loan types as collateral. Increasing delinquency on credit card and student loans often lower spreads of ABS with other collateral. We argue that delinquencies on these types of loans in a household's loan portfolio provide liquidity to other loans. In contrast, rising delinquencies on mortgages, the first to be repaid in the pecking order, are an indicator of a severe shock spilling over to other loan types, triggering a simultaneous increase in ABS spreads. Furthermore, we find for residential mortgage-backed securities (RMBS) a lower probability of future rating downgrades in times of high mortgage delinquency. Thus, ratings are adjusted according to changes in the business cycle.