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The Hidden Performance Risk of Prime Credit Tiers in an Economic Downturn

Jessica Harmon
Blog Post11/12/2020
Credit Trends and Reporting
The Hidden Performance Risk of Prime Credit Tiers in an Economic Downturn

In the wake of the COVID-19 pandemic, lenders are looking to the past to determine the potential impact on their businesses. In the Great Recession from Q4 2007 to Q2 2009, personal loan lenders tightened their originations to reduce their exposure in an uncertain market. By the end of the recession the number of personal loan accounts across the credit risk tiers was just 11.4 million, a 10% decline from Q3 2007 — the last full quarter before the start of the recession.[1]

For a number of reasons, the personal loan landscape looks different now than it did from 2007 to 2009. First, personal loan distribution shifted to more prime and above borrowers in the aftermath of the Great Recession. As of Q3 2020, prime and above accounts represent 54% of personal loans, up from 40% in Q3 2007, right before the Great Recession began. Second, in the current crisis as of the end of Q3 2020, 4.38% of unsecured personal loans are in forbearance or deferment via hardship programs, obscuring performance data that was available in previous crises.[2]

Due to these factors, and consumers’ access to government assistance via the CARES Act, lenders may assume they are in a better position in this recession. This assumption, however, does not account for the impact of consumers migrating to different credit tiers during an economic downturn.

To understand the risks for FinTechs and other unsecured installment lenders, we analyzed TransUnion’s depersonalized consumer credit database to uncover trends from the Great Recession.

Does score migration have an impact on personal loans during a downturn?

Looking at personal loans with a balance between Q3 2007 and Q3 2008, the serious delinquency rate for subprime accounts rose 0.78%. In the chart below, we observe the largest increases in delinquency were among near prime and subprime consumers. In contrast, there was no change for prime and super prime accounts, and the prime plus delinquency rate fell.[3] The same trend held between Q3 2008 and Q3 2009 as there was no change in the delinquency rates for prime and above credit tiers.

Delinquency rates by credit risk tier for personal loan accounts (open or closed) with a balance*

 

Q3 2007

Q3 2008

Difference in Rate

Q3 2009

Difference in Rate

Subprime

12.21%

12.99%

0.78%

13.76%

0.78%

Near prime

0.49%

0.51%

0.02%

0.56%

0.04%

Prime

0.13%

0.12%

0.00%

0.12%

0.00%

Prime plus

0.05%

0.04%

-0.01%

0.04%

0.00%

Super prime

0.01%

0.01%

0.00%

0.01%

0.00%

*Differences may not sum up due to rounding

The limited impact of delinquencies in the prime and above risk tiers — during a broad recession — demonstrates that consumers were migrating risk tiers. As consumers fell into riskier credit tiers, the near prime and subprime delinquency rates grew.

To better understand risk, we analyzed what happened when we kept consumers’ pre-recession credit tiers fixed and looked at open accounts. By freezing these credit tiers, we can more effectively evaluate how delinquencies and charge-offs accelerated within each tier.

What happens when we freeze credit tiers?

With credit tiers held constant, the subprime risk tier still has the highest delinquency rate. However, we can see a different trend in the near prime and prime tiers. In these risk tiers, we observe the largest increase in delinquency rates. Between Q3 2007 and Q3 2008, the near prime delinquency rate grew 3.05%, whereas the subprime rate fell 1.13%. Potential delinquency issues are also evident in prime plus and super prime as they saw slight growth.

Delinquency rates by credit risk tier for personal loan accounts (open only) with a balance*

 

Q3 2007

Q3 2008

Difference in Rate

Q3 2009

Difference in Rate

Subprime

13.61%

12.48%

-1.13%

10.33%

-2.15%

Near prime

0.59%

3.64%

3.05%

4.93%

1.29%

Prime

0.15%

1.36%

1.21%

2.49%

1.13%

Prime plus

0.05%

0.46%

0.40%

0.98%

0.53%

Super prime

0.01%

0.17%

0.16%

0.38%

0.21%

How should these findings inform lenders’ COVID-19 response strategies?

This analysis demonstrates that unsecured personal loan lenders need to monitor all risk tiers during the COVID-19 pandemic, even those considered less risky. In response to economic hardship, lenders should conduct more frequent portfolio reviews using trended credit data and include prime and above consumers.

For example, declines in Aggregate Excess Payment, which sums up a consumer’s additional payments above the scheduled obligation on all debts, provide early visibility to performing customers increasing their financial stress. This provides lenders an opportunity to get ahead of diminishing performance in the near prime and prime credit tiers.

Personal loan issuers should also adjust their models to better forecast potential losses from increases in delinquency and charge-off in the near prime and above tiers. This is needed especially as a significant portion of consumers are in forbearance or hardship programs, which obscures visibility into their financial stability. The table below shows hardship participation rates for August and September 2020, as well as February 2020 – before the onset of the pandemic.

Percentage of unsecured personal loan accounts in hardship*

 

September 2020

August 2020

February 2020 (pre-pandemic)

Super prime

5.06%

5.50%

0.16%

Prime plus

3.33%

4.24%

0.25%

Prime

3.82%

4.67%

0.22%

Near prime

4.84%

5.70%

0.23%

Subprime

5.05%

5.63%

0.17%

Total

4.38%

5.14%

0.21%

* Hardship is defined as accounts flagged as affected by natural/declared disaster, accounts reported as in forbearance, accounts reported as deferred, (except for February 2020 data) payment due amount removal or freezing of account status and/or past due amount.

For more information on understanding and managing an evolving portfolio during the COVID-19 pandemic, visit transunion.com/accountmanagement or fill out the form below.

[1] TransUnion consumer credit database

[2] TransUnion consumer credit database

[3] VantageScore® 3.0 risk ranges; subprime= 300-600; near prime= 601-660; prime= 661-780, super prime= 781-850

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