Monday Musings: May 23, 2022

May 23, 2022

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Public Trust Credit Team
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Subprime loans show signs of shaking despite strong consumer balance sheets

According to Equifax, delinquencies for subprime (meaning FICO score of 580-619) credit card and auto loans have risen for the last eight consecutive months while auto loan delinquencies hit an all-time high in February. Inflation and interest rates are pressuring borrower balance sheets, especially in the subprime category that is leading to the increase. Citigroup estimates that monthly auto payments are increasing by $10-15 a month for each 1% increase in rates and $15-20 per month per $1,000 increase in the loan amount. Rising rates will have a more profound effect on debt with a variable rate like credit cards or adjustable-rate auto loans and could be leading to some of the increase in delinquencies. It should also be noted that mortgage lending has remained relatively strict over the years, leading lenders to embrace subprime credit for other types of loans last year.

To further analyze this risk, we look to the underlying data; overall, fewer people are in the subprime brackets than pre-pandemic due to broadly stronger consumer balance sheets. 18.6% of adults were considered subprime in February 2020 and that number declined to 15.5% in 2021. Citigroup estimates that ~30% of all auto loan originations are subprime, leaving ~70% of the auto loan market in the prime category. While delinquencies are at all-time highs, the Equifax data set only goes back to 2007 and most of these highs were actually hit in 2019 and 2020 before the pandemic. Given the unprecedented government stimulus and the better than normal state of consumer balance sheets because of it, many lenders believe that the increase is more indicative of a normalization than a problem. After periods of rapid growth and declining unemployment, an increase in subprime delinquencies does fit the historical norm.

We use a proprietary process to disaggregate the underlying risks of the asset-backed securities to ensure we fully understand the types of underlying investments present, and we use a team-centric approach to understanding the drivers of this underlying performance. While the increase in subprime delinquencies might be due to normalization, we think it is prudent to continually monitor the market to ensure the performance and credit quality of our asset-backed investments and financial institutions. 

All comments and discussion presented are purely based on opinion and assumptions, not fact. These assumptions may or may not be correct based on foreseen and unforeseen events. The information presented should not be used in making any investment decisions. This material is not a recommendation to buy, sell, implement, or change any securities or investment strategy, function, or process. Any financial and/or investment decision should be made only after considerable research, consideration, and involvement with an experienced professional engaged for the specific purpose. Past performance is not an indication of future performance. Any financial and/or investment decision may incur losses.

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