The unemployment rate has been one of the best ways to predict the trajectory of ABS consumer credit losses seen in the most recent and past recessions.
However, data in the previous several months has shown that, at least for this part of the credit
cycle, this relationship might be changing for now, according to Deutsche Bank Securities analysts in a report released this week.
In the near- to mid-term, the core changes to lending standards and credit consumer use should have a positive effect on card performance and card ABS portfolios, analysts said.
They added that as soon as lending earnestly takes off and standards are loosened to give a chance to borrowers that are not in the top credit tier, they think that the usual correlation between employment and card performance will go back to how it has been. They also predict that some of the new issue card ABS volume will return at this point.
Data showed that in 2010 charge-offs have started to fall ahead of employment, analysts said. They presented data demonstrating that after peaking at 11.4 % in February 2010, the charge-off rate for the Fitch Ratings prime credit card index dipped to 10.4% by September. This an improvement of 9%.
Over the same period, the unemployment rate only improved by 1% while delinquency rates, which is considered a leading indicator of charge-offs, have also improved considerably in the past year, analysts said. This implies further near-term improvements, Deutsche analysts said.
The researchers used data from Moody’s Analytics to prove their analysis. Moody's expects that, given recent industry events, this new relationship might stay the same in the next five to 10 years. It expects charge-off rates to drop to below 3% by 2015, which is a new low.
According to Deutsche analysts, the rating agency cited the unprecedented tightening of lending standards — in place between 2007 and July 2010 — as the primary driver for this new dynamic. This is the longest and tightest period of lending standards in recent history.
Additionally, Deutsche mentioned that “involuntary” deleveraging — i.e. lenders charging off bad debt — has caused an overall improvement to the credit quality in lenders’ portfolios. Moody’s said that the involuntary deleveraging makes up around 75% to 90% of the balance reductions in the past two years. The voluntary deleveraging by consumers, the rating firm said, was only really apparent in the last few quarters.
Banks have generally emerged from the recession with better quality portfolios and improved
balance sheets, Deutsche analysts noted. With spending starting up again, which is driven by pent-up consumer demand as well as a stabilizing labor market, banks should start lending again.
In terms of borrowers, Moody’s said that even though the consumer is still stretched, there have been some improvements to fundamentals and the labor markets have somewhat stabilized. Even though the unemployment rate remains high, given the recovering economy, the massive layoffs that characterized the recession's start is further behind as job creation increases.
Additionally, the rating agency also said that borrowers have changed their borrowing patterns because of either voluntary frugality or limited access to credit.
Deutsche analysts also cited a recent Federal Reserve Bank of New York highlighted the change in the pattern.
The Fed's data showed that consumers borrowed — this excludes mortgage debt and charge-offs — $200 billion per year between 2000 and 2007 on average. Meanwhile, in 2009, consumer net borrowing was negative $13 billion.
Deutsche analysts said that is is debatable whether this change is sustainable as soon as lending and consumer confidence start up again.