Should We Worry About Consumer Credit?

As the credit cycle develops across different economies, our asset allocation changes to reflect that, and if it looks to be at a mature stage in a specific country then our natural focus on credit quality becomes more important; we are always trying to avoid next year’s problem credits, whether in the financial, corporate or securitised markets.

In the securitised markets, with the clear delineation between consumer debt-backed deals (mortgages, credit cards, unsecured loans etc.) and those backed either directly or indirectly by corporates (CLOs or CMBS respectively), this focus on credit quality is something we spend an inordinate amount of time on. In the consumer space there is a significant amount of information for us to work with, both specific to a deal and on a more industry-wide basis. For example, we might look at the credit scoring criteria for a particular lender in a deal, and also look at the trend in lending criteria across the board published in the Bank of England’s Credit Conditions Survey.

However we don’t always get all the information we want, so when we see something new, it can often add insight, and normally leads to more questions. On that note, the Bank of England have a blog called Bank Underground, for its staff to challenge or support commonly-held views on relevant topics (nb: The Bank emphasizes that the views expounded are not necessarily those of the Bank). On 3rd January, the blog published a piece called “Who’s driving consumer credit growth?”, which challenges some of the more recent concerns around consumer credit growth. Many commentators have recently looked at the growth of consumer credit in the UK and asked whether the strong growth seen represents a threat to financial stability, particularly as the debt servicing burden increases in a rate-rising environment, but also due to that growth potentially being in non-traditional and higher-risk products.

The added insight from the blog is that it has access to something we don’t – namely a 10% sample of data from the credit reference agencies on consumer debt, which is interesting as the existing data set (Credit Conditions Survey) only comes from the UK’s banks and building societies, so misses all the specialist lenders. It also shows the crossover between different data sets – what is the credit quality of the borrowers that are using higher risk products, what products are driving growth and so on. 

So what have we learned?

The blog breaks down the credit profile of the UK consumer in the unsecured or personal credit space – so it carves out the mortgage market. One set of data published looks at the different products on offer and analyses what the credit profile of the borrowers in that product looks like. The top 50% of credit scores account for >80% of consumer credit, so immediately you can see that it is heavily biased towards good quality borrowers.

Fine, that makes sense, better credit scores should have better access to credit and are more able to get credit in bigger size.

What about the riskier products – zero-interest credit card deals for example? Here it is even more biased to the higher credit quality, with the same top 50% of scores covering >90% of the lending done, and roughly the same in auto loans, a sector that has attracted a lot of interest recently. These are the two areas that have driven the growth in consumer lending apparently, and so it is comforting to see that this is not case of risky products going to risky borrowers.

Further to this, the distribution of credit scores outstanding has not changed from the end of 2014 to the end of 2016, and the flow of new accounts during 2014 and 2016 were almost identical, and of higher quality than the number outstanding at the end of 2014. In other words borrowers’ credit profiles were stable but lenders were reducing risk through this period.

Further analysis done points to the majority of growth in consumer lending coming from borrowers without mortgages which the authors interpret as positive in that it shows that the tightening of lending standards post Mortgage Market Review hasn’t forced borrowers who can no longer release equity to seek alternative funding. We have some reservations here, as do the authors, as non-mortgagees can be split into those that own their own house outright, and those that rent, and clearly one of those will have a lower debt burden as they neither pay or a mortgage nor rent, and therefore are likely to be a better credit, but less likely to be looking for financing.

On a slightly negative note the research also points out that the presumption that borrowing on a short-term basis meant that debts were quickly paid off is incorrect. Borrowers who held these products in November 2016 were largely the same borrowers who had it two years earlier. This might not be ideal, long term borrowers should probably be funded by long term debt, but on the other hand having a track record of servicing this burden offsets that to some extent.

This report only discusses data in the two year period from 2014-16, but it is useful additional insight in that it answers some of the questions that are being asked in the media at the moment around the growth of “higher risk” products. 

These products are not all accessible in the European securitisation markets which is a positive, however the information does fill in the back-story to some extent. 

Notably the same cannot be said of the US market, where sub-prime auto securitisations have become a recent feature, as have other “late cycle” products, which points to the credit cycle’s turn being that bit further along than in Europe, and as we continue to assess relative fundamental performance it continues to weight the argument in favour of European ABS.