Sub-Prime Lending’s Late-Year Bounce

According to the latest Q3 2018 TransUnion’s Industry Insights Report the back half of 2018 has been a good year for sub-prime borrowers looking for access to credit. In the year between Q2 2017 and Q2 2018, sub-prime consumer loan originations grew 28 percent between Q2 2017 and Q2 2018 across the categories of auto loans, mortgage loans and credit cards. This reverses the previous year’s trend, between 2016 and 2017, when sub-prime loan originations across categories fell by 7.1 percent.

Matt Komos, vice president of financial services at TransUnion, said this indicates a growing risk tolerance among lenders across underwriting categories.

“In 2016, the market experienced a pullback as lenders slowed or stalled sub-prime originations,” Komos said. “The pendulum is starting to swing back, as we see lenders once again extend credit to sub-prime consumers.”

In some areas, the growth in sub-prime lending matches overall growth in the segment, with credit cards and personal loans as the best example. Prime and super-prime card issuing both showed positive growth between 2017 and 2018, according to TransUnion, which has been the trend for the last several years. Sub-prime issuing also ticked up 3.6 percent, which had not been the previous year’s trend. Issuers, according to the data, offset the risk in delinquencies or defaults brought along by lower credit score borrowers by reducing credit limits for such consumers. Personal loans outstanding rose 18 percent to $132 billion in September, with the sub-prime segment growing at the fastest rate with 28 percent expansion.

In other areas, most notably mortgage underwriting, the uptick in sub-prime originations is against the overall trend in the segment, where underwriting has been flattening since 2017 and throughout 2018. The downward pressure in the mortgage segment is attributable to a few different converging factors: rising interest rates and rising home prices. Given those two pressures, consumers who a few years ago might have traded up a starter home for a larger model are increasingly likely to stay put. That has meant a dearth of so-called starter homes on the market, further depressing action.

But while mortgages in general have been fairly flat, sub-prime mortgage loans actually grew their origination rate by 3.4 percent year-over-year, representing the largest volume of sub-prime loans originated in the second quarter since the Great Recession 10 years ago, according to TransUnion.

The sub-prime mortgage segment has also performed strongly in terms of delinquencies, in line with overall trends in the mortgage world since 2009. Sub-prime mortgages, however, performed notably well this year, with delinquency rates dropping from 20.44 percent to 18.63 percent. That drop in delinquency rates was also notable in the near-prime risk category (consumers with FICO scores above 640 but below 720), where delinquencies fell off 15 percent between 2017 and 2018.

In fact, that lowering delinquency story was also one that occurred across segments. Auto lending saw its sub-prime loans delinquency rate improve by 15 basis points, from 6.9 percent in last year’s third quarter to 6.82 percent in this year’s third quarter. That result was especially important in sub-prime auto lending, according to TransUnion’s senior vice president Brian Landau, as mounting concerns about a sub-prime auto lending bubble has been depressing activity in the sector for the last several years.

“The market was heating up, growing at double digits, and a lot of people were waiting for it to pop,” Landau said. “It never happened. It shows the resiliency of the market.”

How long the market will be resilient, and how long lenders will be excited to extend credit to sub-prime borrowers (or in general), is a question that remains up in the air, however.

U.S. household debt recently sailed past the record level it held in 2008 just before the big crash, hitting $13.5 billion last quarter. Debt numbers have been on the incline for the last four years, presently sitting more than 21 percent above the low point hit in 2013. The $219 billion rise in total debt in the quarter that ended Sept. 30 was the biggest jump since 2016. This has led some to speculate that a slowdown is coming, particularly if delinquency rates begin to rise more sharply.

And there are signs that some underwriters – particularly those who are more likely to cater to sub-prime and near prime borrowers – are beginning to pull back for fears that consumers are becoming over-leveraged.

Capital One Financial and Discover Financial Services are both tightening lending standards, despite the fact that at present, there are no indications that consumers’ ability to pay back their debt is worsening, according to The Wall Street Journal.

“In so many ways, one can’t help but be struck by … just how good the economy [at] this point is,” Capital One Chief Executive Richard Fairbank said on the company’s earnings call, which was covered by The WSJ. “And in some ways, it almost feels too good to be true.”

According to the report, both firms are used as reliable gauges of American consumers’ ability to handle debt, since neither brand caters to affluent or super-prime credit consumers. The WSJ noted that 33 percent of Capital One’s domestic card balances are owed by consumers who are considered sub-prime. Both are also reining in their issuing, card sending limits, balance transfers and the pace at which they increase credit lines.