Should Investors Be Worried About Consumer Borrowing? by Shawn Pierce, Columbia Threadneedle Investments
- Credit to prime and non-prime borrowers is expanding, which is helping support the consumer.
- Repayment and delinquency data suggest that borrowers are handling most debt burdens relatively well.
- Student loan debt is a headwind, but the government has shown the willingness and ability to offer payment assistance, which is helping to dampen the effects of the growing burden.
One of the main causes of the credit crisis was an over-levered consumer, both on a housing and personal basis. The crisis forced credit conservatism and deleveraging on lenders and consumers alike. Now that balance sheets have been repaired, credit is becoming more available and consumers are taking on additional debt. Articles such as Bloomberg’s It’s Gotten Pretty Darn Easy to Get a Car Loan highlight lower auto loan rejection rates, which have driven light vehicle sales to the highest point since July 2005. There are concerns that credit standards have become too loose and the lessons of the recession have been forgotten. However, current performance indicates that lenders and borrowers have not extended too far.
Post-recession, consumer credit remains a major economic driver. While credit availability was lower for prime borrowers, it essentially stopped for subprime borrowers. Subprime auto loans were only offered to customers who qualified under stringent underwriting, while credit card borrowers were effectively cut off from traditional funding sources. However, we have seen positive trends in accessibility, as well as performance, that should continue to be a tailwind for the consumer.
Prime auto loans continue to perform exceptionally well, with low delinquency and default rates indicating a healthy prime borrower. Subprime borrowers are finding credit cheaper and easier to source, and they have had acceptable performance thus far. Performance comparisons to immediate post-recession lows are misleading, since few creditors were willing to extend loans to the majority of subprime borrowers in the middle of the recession. Subprime loan underwriting has loosened and performance has worsened, but both seem to have stabilized.
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Exhibit 1: Auto loan delinquency
Source: Bank of America Merrill Lynch, 07/15
Performance for credit cards implies that creditors remain prudent and consumers are paying their bills. Delinquency and charge-offs are at or near all-time lows and borrowers are paying a higher percentage of the balance per month. A significant portion of the improvement is due to a reduction in the number of subprime credit cards after various legal and regulatory actions made it more difficult for creditors to price risk. As a result, major credit card performance numbers primarily reflect prime borrowers with subprime borrowers having to seek unsecured credit elsewhere.
Exhibit 2: Credit card performance
Source: Fitch Credit Card Index, 07/15
Subprime unsecured borrowers are finding new avenues for credit beyond traditional banks. Non-bank companies such as Springleaf Financial and OneMain Financial have extended mostly unsecured consumer term loans to subprime borrowers as a replacement for the credit cards they have lost. Current performance for Springleaf loans has been very good compared to pre-recession and recession numbers. Comparisons to immediate post-recession performance shows an increase in charge-offs but, like subprime auto, credit was much tighter immediately following the recession. Peer-to-peer lending has also emerged as a new source of credit for non-prime borrowers.
Exhibit 3: Springleaf consumer loan annual charge-offs
Source: Springleaf Financial, 07/15
Student loans are an area that continues to show weakness and presents a headwind for the consumer. Delinquency and default performance remain elevated compared to pre-recession levels, and debt outstanding is now over $1 trillion. While this does present challenges to certain demographics, the government has many tools that can be used to mitigate the impact of the loans, including deferment and forbearance. Both of these are already being used extensively. Additionally, the government has increased availability of income-based repayment plans (not captured in the data here) that cap payments at 10% of disposable income and forgive the remaining balance in 20–25 years. All of the payment options should help soften the hit to disposable income and reduce the headwinds of growing student debt burdens.
Exhibit 4: Student loan performance
Source: Bank of America Merrill Lynch, 07/15
Credit availability at this point in the credit cycle appears to be stable for prime and improving for subprime borrowers, respectively. Delinquency and default performance for prime borrowers are at historically low levels. Subprime performance has deteriorated slightly from recent historically tight credit but remains acceptable. It is our expectation that losses may increase slightly, but lenders and borrowers appear to be acting rationally, at least for now.