By Ray Birch
DALLAS—Just six years after the Great Recession, are borrowers and lenders forgetting the (very recent) past?
Analysts interviewed by CUToday.info are in agreement: the answer is yes and no for a number of questions. Are lenders taking on too much risk and lowering standards on loans just to keep the lending pipeline full? Are consumers saddling themselves with debt bordering on unmanageable levels—threatening their personal balance sheets and possibly the economy?
Some analysts see red flags starting to go up the pole in auto lending and credit cards. Yet even for those who believe there are no indications of impending trouble, analysts agree it’s time to exercise prudent lending, especially with auto, which shows signs of slowing sales and increased competition among lenders that could lead to a greater reach into subprime, where delinquencies are rising. Lenders, too, are being urged to pay close attention to indirect business.
“Have we already forgotten or are we just ignoring the lessons from our recent past?” asked Brian Turner, executive director with Meridian Alliance. “We certainly seem to be returning to economic and market profiles that existed in 2007, just prior to the recession, although we see growth in consumer spending at a much slower pace.”
Turner believes it is a critical time financially for both the nation’s consumers and the financial institutions that serve them. Over the past few years, Turner told CUToday.info, consumers have hesitated to expand their spending behavior in light of job insecurity and stagnant wages, despite a period of historically low interest rates.
“Until a couple of years ago, financial institutions had been equally hesitant in over-extending their credit risk profiles and tightened their underwriting standards. For instance, during the 2007-2009 recession, the average FICO score for approved loan applications rose from 711 to 733,” observed Turner.
Household Debt Rising Again
Brian Turner, Meridian Alliance
From 1993 to 2008, Turner said consumers’ household debt service ratio—the percentage of total required household debt payments to total disposable income—increased from 10.3% to 13.5%. In 2008, mortgage debt servicing reached 8% of disposable income, while consumer debt servicing hit 6%.
“Since then, mortgage servicing dropped to 4.5% and consumer servicing to 5%. This certainly improved consumers’ financial situation by reducing their debt load and improved their disposable income, especially during a period of stagnant wages and weak job growth,” said Turner. “Despite experiencing the benefit of lower delinquency, it left financial institutions to scramble for assets to cover the principal runoff of loans, both consumer and mortgage. And that seems to have forced the current issue.”? While mortgage debt has stabilized over the past three years, consumer debt servicing has once again increased from 5% of disposable income to nearly 6%—despite little growth in average wages, noted Turner. According to the Federal Reserve, over the last four years consumer credit has increased 21% with non-revolving credit, which includes auto and student loans. Credit union market share of those loans has increased from 9.6% to 11.3%.
“Now, we are seeing a rise in the rates on subprime loans—generally those with higher risk because of a weaker credit history—potentially reaching 17.5% in 2016,” said Turner. “This would be the highest rate since 19.6% in 2007—just prior to the start of the past recession.”
Over the past two years alone, credit unions have seen a well-documented 32% increase in vehicle loans, but also a 17% increase in mortgage loans, pointed out Turner. In 2015 alone, vehicle loans increased 14%. There also has been a dramatic increase in CU indirect originations since 2012, rising from 12% of total loans to 17% of total loans. Moreover, indirect delinquency stands at 0.72% versus direct new vehicle delinquency of 0.42%.
However, as an industry, most of the increase in CU loans has been attributable to larger credit unions—$500 million in assets or greater—which account for 72% of industry assets but only 8% of the number of credit unions. In fact, whereas CU loan growth in 2015 was 10.5%, credit unions less than $500 million in assets—about 92% of the number of credit unions—experienced growth of only 0.4%, said Turner.
“This suggests most of the industry continues to struggle with loan demand, and possibly could lead to easing certain underwriting standards or turning to more indirect origination to cover scheduled loan runoff,” offered Turner. “But as J.D. Power’s John Humphrey cautions, ‘Automakers must avoid the perilous path of chasing volume and market share with easy credit and heavier incentives.’ Moreover, he says, ‘The industry has to be disciplined in the upcoming period of slower growth.’”
Highest Card Debt Since 2008
A new study by CardHub finds that Americans have the highest average card debt since 2008. The study, previously reported by CUToday.info, shows that the average household has $7,800 in credit card debt—debt nearly the reaching unmanageable levels exhibited just prior to the financial crisis. That means that 2016 might be a repeat of 2008, the company cautioned.
“With consumer confidence high, more people are spending more than they can afford,” said Jill Gonzalez, analyst for CardHub and WalletHub, Washington. “Americans have become shortsighted about what happened less than a decade ago. Yes, I know, people today say things were different in 2008—we did not have full employment like we have now, people are more secure with their jobs, wages are still an issue, so why would it look like 2008? The factors are not there.”
But Gonzalez said that while the same economic factors may not be present today, an entirely new set of issues are present.
“From historically low oil barrel prices to a presidential election—presidential elections always limit GDP,” she said. “And there are external factors like China. All these things combined, with the same type of credit behaviors as in 2008, are definitely pretty scary.”
If something does not “give” soon, suggests Gonzalez, such as a big consumer credit card debt paydown this quarter or Americans’ spending habits changing, then the country is “looking at another recession.”
For lending overall, despite issues among subprime borrowers, delinquency and charge-off rates remain near the low post-recession levels. “The only thing increasing is the spending,” said Gonzalez. “Take the end of 2015. During Q4, we spent more on credit cards than we did in the entirety of 2014.”
Jill Gonzalez, WalletHub
Analysts say that the economy may be able to absorb the debt load if it does not experience a shock. But in oil-producing regions of the country, that shock has already taken place with plummeting oil prices.
“I think industrywide there is a concern, it’s the next pig in the python, the next little bubble that exists, and it’s doubly compounded in our local market because financial institutions in the Houston area are starting to see a rise in delinquencies and charge-offs because people are being laid off,” said Dave Bleazard, president and CEO of the $597-millon First Service CU. “The oil business is very sick and I don’t think a change is coming anytime soon. So having careful controls on underwriting is very important.”
Auto Delinquencies Rising
According to TransUnion, the national auto loan delinquency rate increased from 1.16% in Q4 2014 to 1.24% in Q4 2015.
“This is the highest level since Q4 2010 when auto delinquency hit 1.22%,” said Turner. “As energy prices took their 50% decline over the past year, auto loan delinquency rates experienced double-digit increases in energy-rich states such as Louisiana, Oklahoma, North Dakota, Texas and West Virginia. Louisiana had the highest rate at 2.57%, while Oregon had the lowest at 0.57%.”
As the price for a barrel of oil has declined, states such as Texas, Oklahoma, Louisiana and New Mexico have experienced between 14.5% to 15.3% increases in auto loan delinquencies, Turner noted.
In Lombard, Ill., Bill Handel is on the fence about whether borrowers and lenders are making mistakes now that could lead to economic trouble, saying lenders should be prudent but that the country should not overreact.
“The notion that we are approaching were we were in 2006 to 2008 is probably a little overstated, but it is wise to show caution,” said the SVP of research at Raddon Financial Group.
Overall Debt Now Higher Than Pre-Recession
Handel recognizes that the level of overall consumer debt today now exceeds the level seen prior to the recession. “So we have blown through that ceiling. But at the same time credit card debt is actually 8% less than what it was then, not even close to peak. But it has been growing.”
Handel said the real drivers of consumer debt have been auto and student loans, both of which he said should concern lenders.
“We see clearly in our research that consumers recognize they don’t have a proper level of debt,” said Handel. “They have a high level of debt just seven years after the financial crisis. Consumers in our research say they recognize they have a problem and want to reduce their debt, but they are not doing that.”
Bill Handel, Raddon
Like Turner, Handel is worried that if auto sales slow lenders will reach deeper into subprime to keep the pipeline flowing. Handel said Raddon is seeing signs of a declining rate of new auto sales, coming off a peak of 17.8 million units last year.
Handel said he expects that will drive competition for business among lenders and dealers, many of which will reach down to lower credit scores. He urged lenders to be prudent and follow lending guidelines, and to watch dealers closely.
“I think the biggest concern for the industry is the indirect space,” said Handel, who added that he believes dealers are already turning more to subprime borrowers. “Dealers want to continue their sales at the current record pace and will look for someone to write that credit. Credit unions just have to make sure they are not in that space. They need to closely monitor the quality of the loans they get from dealers.”
No Need To Worry
Christine Pratt, senior credit analyst at Aite Group, Boston, said she is not concerned about the current levels of consumer debt and delinquencies.
“I see no reason to have economic angst,” she said. “We are really not seeing higher delinquency rates today. The subprime market will always be a bit tough with delinquencies. But when we look at the overall market I am not seeing any danger.”
Dwight Johnston, chief economist with the California and Nevada CU Leagues, who had predicted the mortgage bubble long before it burst in 2008—even selling his California home in advance of the crisis to avoid a huge loss—does not think consumers are getting in debt over their heads to a point where the economy will suffer.
“Consumers are feeling better about their jobs and futures and are more willing to borrow. They are tired of holding off on purchases. But can they over extend? Sure. But as long as mortgage debt remains strict, I don’t worry from an economic perspective,” Johnston said.
Melinda Zabritski, senior director of automotive finance for Experian Automotive, Schaumberg, Ill., said it is time for lenders to pay attention to the market to make the best decisions, but that there are no red flags flying.
“Overall, from an auto standpoint, we are seeing delinquencies rise. But it’s not an unexpected rise, since we have been growing subprime,” she said, adding that a sizeable portion of the late payers have credit scores below 500. “But we are still at subprime levels lower than pre-recession and delinquency levels lower than before the financial crisis.”
Melinda Zabritski, Experian
Subprime Borrowing
Zabritski said subprime loans comprised 30% of the auto market prior to 2008 and 25% of borrowers today.
“Again, I see no immediate reasons to raise red flags,” said Zabritski. “Lenders just should make certain that they are pricing loans to accommodate (for subprime delinquencies) and that reserves are properly set.”
Pratt stated that the rise in subprime loans should simply be expected as these loans season.
“In 2013 about half of the overall U.S. auto loan portfolio turned over,” said Pratt. “As these new loans came on the books it takes a couple years for those to ramp up—these loans don’t go bad all at once.”
But Gonzalez thinks the fact that overall lending delinquencies are holding fairly steady, outside of subprime, may simply mask impending trouble.
“I think this year will be very telling, and I think delinquencies will pick up. We are no longer at the 0% interest rates, and the Fed may raise rates again this summer. Then, we may see delinquencies begin to increase and credit tightening up again,” she said.
Diversify The Portfolio
Handel said the wise move for credit unions is to diversify away from a heavy concentration in indirect auto.
“Even though the last crisis was real estate, the real estate markets are probably healthier today than they have been in 20 years,” said Handel, adding that Gen Y homebuyers should keep the pipeline flowing. “I would look to lessen my dependence on indirect auto.”
Analysts agree that any potential problems ahead for credit card, auto loan, and even student loan debt do not represent the size of the risk to the economy presented by mortgages in 2008.
“Both credit card and auto loan debt together don’t come close to posing a threat like the mortgage market,” observed Johnston. “On that front, standards are still very tight. If I start hearing of big security deals with subprime mortgages, then I’ll worry. But that isn’t happening.”
But Handel said that with talk of a possible recession in 2016, as the country is 80 months into the current expansion, as well as the lower-quality auto loan borrowers that have been placed on the books in the past year, could present problems as many would struggle to pay for their loans during a recession.
“Yes, the potential problem is not nearly as big as the mortgage bubble, but problems with auto lending could shift the balance of the economy, so it is something to watch,” insisted Handel.
Turner contends that if economic trouble hits this year the U.S. could be headed for a recession the Fed could do little to control.
“It is more perilous today than in 2007 due to the relatively low rate environment in which we are in,” said Turner. “Should growth rates decline, both GDP and consumer spending, the Federal Reserve has fewer sources available to it to remedy a deep recession. At its best, we would be faced with an even more protracted path to recovery than the current seven-year pace we are currently on. On the other hand, if consumer spending stabilizes in 2016 and 2017, even if it results in a modest 2.5% economic growth, the nation’s consumers and financial institutions will be able to circumvent what could remain a volatile environment.”