Ryan Grippin, Sr. Advisor, Product Marketing — Global Credit Risk
Inflation, central bank interest rate increases, and rising energy, food and housing costs — these dynamics have almost every household feeling the economic strain, leading to fewer consumers entering the lending market. People are prioritizing food, shelter and energy, allocating remaining funds for servicing debt obligations. When the squeeze gets tighter, credit cards are the first obligation to go unpaid. For those in the lending business, it seems like troubled times could be ahead.
I sat down with TransUnion SVP of Research & Consulting Charlie Wise — an authority on credit decisions across the customer journey — to get his perspective on economic pressures and the balancing act of finding resilient consumers while managing risk in troubled times.
RG: A search of today’s world economic headlines describes conditions of a perfect storm of events affecting the global economy. These are now being felt in terms of record inflation, a forecasted drop in world GDP, and a dramatic reduction in consumer spending power. For lenders, it’s a pretty bleak picture when faced with maintaining their levels of business. What advice would you offer as we watch developments in the markets?
CW: We’ve seen times like this before, and smart businesses are able to weather the storm by taking a hard look within. In many markets, we’ve seen a drop in secured lending because of affordability challenges. In some cases, the number of loans has dropped, but the value of the loans — in both mortgage and auto — has increased. In that regard, the top line is actually growing in terms of outstanding balances, but it's off an increasingly smaller origination base because increasingly fewer consumers can afford to buy.
This illustrates a bit of a phenomena about lending: If you stop lending, or dramatically reduce new loans you write because you’re looking only for those with pristine credit, the percentage of delinquent loans will increase. This is because if you don’t book new loans to replenish those coming off your portfolio, the good ones pay off and the bad ones go bad. If you're not growing your portfolio, you're seeing a shrinking denominator and rising numerator — a recipe for a huge spike in delinquencies. This creates an imperative because with the ‘do nothing’ strategy (reducing or stopping lending), you pretty much guarantee a year from now, your portfolio will look a lot worse than it does today. My advice is if you want to protect your portfolio, find prudent growth opportunities as opposed to shutting off lending.
It’s clear many lenders are understandably cautious and turning their focus to people with pristine credit scores, but there aren’t many in that category looking to borrow money — even in bad times. And unfortunately for those who do need credit, lenders are pulling back. So, how can lenders gain confidence in identifying resilient consumers who can essentially outperform what’s reflected by their credit scores? I think this is where we get into the question, “Is the credit score the single point of truth about a consumer?” And in my opinion, it really should not be in many markets.
Lenders simply have to look at submitted applications more closely and make the best decisions possible for their businesses. In some cases, that translates to identifying and providing quality offers to consumers who aren’t as impacted by inflation or at least have a more substantial financial cushion.
The post-pandemic recovery and corresponding jobs reports also suggest people are headed back to work or beginning work for the first time. This could mean someone without a long work history or long credit history is looking for credit for a car, house or large purchase as they start out on their financial journey. New-to-credit consumers represent an opportunity lenders often overlook — simply because they’re invisible on most common reports. To say we have a perfect storm with inflation on the rise, consumer-spending power reduced, and subsequently no new opportunities in the market just isn’t accurate. There are ways to manage and achieve profitable growth — even in a so-called perfect storm.
RG: We’ve all read about rising costs of food, energy and housing creating a squeeze on the average household. The Q4 2022 TransUnion Consumer Pulse Study found about half (48%) of respondents were ‘very concerned’ about meeting all their financial obligations. Other consumer interviews tell us people will keep paying for the roofs over their heads and food on their tables, as well as their electricity. Then they’ll make financial space for servicing debt like credit cards, auto loans and unsecured personal loans. How do you see these factors impacting the risk of delinquency and default, and how does a lender manage their portfolio?
CW: There are certainly challenges. When the cost of everyday, vital necessities increase by 20% to 30%, you're almost guaranteed there will be some tightness in bottom-line budgets. This is where we really recommend building an understanding of consumers and their demonstrated capacities to pay. Consumers will still be looking to borrow in this market, so knowing which ones are more vulnerable versus those who are more resilient is an important art. The problem is a credit score doesn't tell you the consumer’s income or debt levels — critical aspects for determining capacity to pay.
RG: Balance transfer and debt consolidation… I can imagine consumers in this market watching their near-term and retirement savings slowly erode as they use those funds to meet obligations. With no clear improvement in the economic forecast, can lenders safely and smartly help those consumers seeking ways to protect themselves from this downturn?
CW: I actually think there are opportunities here. Increased cost of living and interest rates create a double whammy: Consumers are carrying higher balances and paying more in interest on them because of rising rates — putting a real squeeze on them. This presents an interesting opportunity to employ insight products that help intelligently find consumers who would benefit.
As a personal loan lender, presenting debt consolidation loan offers to consumers who have relatively high-cost credit cards with high balances can prove to be a win-win situation: You can lower their interest and monthly payments, consolidate payments, and hopefully get them through this challenging time — subsequently helping cultivate loyalty to your institution.
To make the most of these opportunities, it ultimately comes down to having the tools to differentiate between vulnerable consumers who may be on the verge of collapse and more resilient consumers who are just looking to get back on track. TransUnion has done several studies in different markets looking at debt consolidation lending, and methods to find and target resilient versus vulnerable borrowers. There may be 100 consumers with marginal credit scores out there, and we can identify the 40 or 50 who are good bets and set aside the rest. TransUnion can help find those consumers who are going to outperform their basic credit scores.
Check out our latest insight guide for best practices around building portfolio resiliency and managing smart growth in uncertain times.