Weekly Industry Update: Credit Trend Through Delinquency Rates

By April 24, 2017Blog

Banks earnings season continued this week following strong Q1 results from JP Morgan and Citi last week. Morgan Stanley beat expectations on each line of business increasing year-over-year profits by 82%. The investment bank also generated 122% YOY revenue growth in the fixed income currency and commodities business. Bank of America exceeded expectations and benefitted from the greater net interest income due to a rise in long-term rates.

For the first time since 2015, GS surprised analysts by missing expectations on top and bottom line performance. Fixed income revenues were flat year-over-year trailing double-digit business unit gains across peers including JPM, C, MS, and BAC.

Bloomberg reports that, Navient, the largest servicer of student loans, reached an agreement to purchase JPMorgan’s approximately $6.9 Bn FFELP education loan portfolio.

In the ABS space, Yirendai reported its progress in funding consumer loan products via ABS. Another Chinese online lender, China Rapid Finance, announced that it plans to list on the NYSE, making it the second Chinese online lender to go public in the US.

We are often asked by investors whether credit card receivables are a proxy for installment loan performance. This week, we dig into credit performance of credit card securitizations representing over $100 Bn+ in consumer credit ABS deals. We include the following issuers in our analysis: American Express, Bank of America, Discover, Capital One, JP Morgan Chase, and Citi.

We compare delinquency and loss levels of credit card ABS to installment loans and conclude that credit card ABS performance is a poor proxy for installment loans, and that installment loan delinquencies are arguably a leading indicator of credit risk.

Credit Card ABS – A Strong History of Credit Performance

The credit card ABS market has historically been the benchmark sector in consumer ABS due to its liquidity, transparency, and strong performance including through the Great Recession.

The Credit Card ABS market is not an originate to distribute risk-transfer market, but rather a critical channel for funding and liquidity. Issuer incentives are strongly aligned with investors due to their dependence on debt capital markets for funding.  Credit Card ABS provides over 50% of funding for card issuers (followed by deposits). New Credit Card ABS issuance is expected to grow in the wake of higher rates and funding costs from deposits.

Post-2008, new ABS issuance contracted significantly, including in the credit card markets. Consumers entered a de-leveraging phase reducing demand for loans. Large banks, in response to the new capital and liquidity regime, shifted to borrowers with higher credit scores and focused on existing relationships. Wider spreads and higher capital charges also reduced available sources of funding for consumer credit.

Post-crisis, non-bank lenders emerged to fill the lending gap by offering installment loan products to expand access to credit. Since installment loans sometime re-finance higher rate credit card debt, some investors have drawn analogies between credit card performance to installment loan debt.

Credit Card ABS Delinquencies are Near Multi-Decade Lows

In our March 2016 newsletter, we discussed credit card master trust performance, noting that delinquencies from 2011 through 2015 followed a downward trend for major credit card issuers.

We continue our analysis below, observing delinquencies continuing the downward trend in 2016, reaching historic lows in early 2016.

While the Composite index shows this trend, there is variability among the individual trusts. Discover and Capital One, with a mass-market tilt in customer base, experienced larger rises in delinquencies, compared to Amex and Chase which have a mass affluent footprint.

Exhibit 1 Credit Card Trust 30+ Day Delinquency Rates

Source: Federal Reserve

Installment Loans Lead Credit Card Losses

There are limitations in comparing delinquency rates on credit card ABS to installment loans. For instance, unlike MPL ABS deals which consist of static pools, credit card trusts are revolving securitizations that re-invest principal and interest over time. Also, we do not have access to the credit score distributions for credit card issuers to compare risk on an apples-to-apples basis.

Nevertheless, when comparing credit card ABS performance to the PeerIQ loan performance monitor we can draw some conclusions:

  • Delinquencies on credit cards reached multi-decade all-time lows in early 2016.
  • Credit card delinquencies are in early stages of reverting to historical levels, whereas the Loan Performance Monitor indicates that the unsecured personal installment loans have started a pattern of higher losses in successive vintages starting in 2015.
  • Through-the-cycle losses on credit card products are lower than losses on installment lending products.
    • Peak delinquencies in credit card ABS are ~8% in a stress scenario. By contrast, three-year unsecured personal loans (such as loans in the seminal CHAI shelf) are typically associated with a ~12% cumulative loss estimate (under a benign base case).
    • Note: We should expect higher losses on installment loans as non-banks offer access to credit to borrower segments outside of a traditional bank’s higher credit score underwriting box.
  • Historical credit card performance data is a poor proxy for measuring installment loan performance.

We can also offer the following tentative hypotheses which we look forward to testing with our TransUnion partnership:

  • Installment loans are lower in the consumer payment priority stack.
  • Installment loan losses lead performance in other asset classes such as credit card.
  • Credit card account management strategies (e.g., re-pricing of delinquent loans, credit line decrease tactics, etc.) are powerful levers for managing risk as compared to installment loans where issuers can only set terms at time of approval.
  • Deeper borrower relationship engagement (as measured by breadth of product penetration) reduces borrower’s credit risk all things being equal.

We look forward to expanding on payment priority trends in subsequent newsletters and via the PeerIQ analytics platform.

Conferences:

  • What’s Next in Fintech Lending? – PeerIQ Breakfast and Panel Discussion
    • PeerIQ will host a panel on May 9th at 9AM featuring a roundtable discussion led by Peter Rudegair of WSJ and joined by thought leaders including: Jason Jones, Co-Founder of LendIt, Zhengyuan Lu, principal at Victory Park Capital, Greg Nowak, partner at Pepper Hamilton and Ram Ahluwalia, CEO of PeerIQ.
    • Space is limited to 20 slots, so please RSVP to confirm attendance.

PeerIQ in the News:

Industry Update:
  • Santander Awaits SEC Go-Ahead (AB Alert 4/21/17) Santander is close to winning SEC approval for a revised version of the trust it uses to securitize its lowest-quality auto loans.

Lighter Fare: