Determining credit risk in 2022 is murky, but still, it’s critical to focus on credit risk scores to craft collections & recovery strategies in 2023, and to predict volume and liquidity of delinquent debt. Keep in mind, 2020 and 2021 were anomalies, and we're still seeing economic course correction. To get a clearer picture of credit risk score trends in 2022, here are five critical takeaways from 2nd Order Solutions’ Q3 Credit Risk Review:
Risk on prime borrowers remains low, for now.
Risk is still below pre-pandemic levels for higher-income earners and prime borrowers, but it’s creeping up. This could be a simple correction, or something more concerning. All-time low unemployment rates, plus excess savings from the pandemic will continue to protect prime borrowers for a time. However, this group was affected by unemployment disproportionately in 2008, and as interest rates rise and the job market cools, this group could become much more risky.
Consumers are paying secured loans.
Consumers are still paying their auto and mortgage loans. In fact, subprime auto loans had “far higher cure rates” than Consumer Unsecured. Mortgage delinquencies are also low. Both of these loans tend to be at the top of consumer’s payment hierarchies, so any increase in delinquencies or a reduction in cure rate is an economic alarm bell.
Student loans are paused again.
Student loans are a huge piece of the consumer debt picture in the US, making up 30% of the non-mortgage debt. They’ve been on pause since 2020, and recently the pause was extended through August 2023 at the latest. When payments resume, credit risk will immediately increase across all asset classes. The student loan forgiveness plan won’t have much immediate effect on that increased risk, either. Collections & recovery executives should be aware of the economic impacts that will occur when payments resume, and be prepared to change their strategy to accommodate consumers who have less liquidity. Lenders should also anticipate a lower cure rate and a decrease in originations for the same reason.
Context is critical for understanding risk scores.
Credit risk scores are “warped” right now, which leads riskier, subprime borrowers to look like near-prime on paper. One reason is the student loan payment pause. Other reasons include Buy Now, Pay Later trades (and really, a potential overextension that’s nearly invisible), credit builder traders, and data degradation caused by COVID. The risk scores of individual consumers are incomplete and that makes it difficult to prepare for a potential increase in collections & recovery.
Tightened underwriting is key to performance.
Origination and underwriting were relaxed in Q3-Q4 2021, and those vintages are demonstrating increased risk, while lenders who tightened underwriting in 2022 are seeing better performance and less risk. The relaxing of underwriting standards during 2021 was partially due to the record gains, as well as the warped credit risk picture. This bodes well for a less-acute economic downturn, as originators have since corrected course when it comes to underwriting. With reduced originations, the focus naturally turns to downstream account servicing, so collections & recovery departments will need to have an extremely effective 2023.
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