Varun Surapaneni from Neuberger Berman notes that the percentage of past-due loans “to riskier consumers has begun to flatten, while newly issued paper is carrying higher interest rates.”
In an update titled, A Turning Point in Sub-Prime Credit, Varun writes that “after a challenging period of rising loan losses, we believe selective pockets of the consumer-credit market could be firming up.”
As stated in the update, consumer credit spans “everything from student and auto loans to credit cards and home-improvement loans.”
As explained in a blog post, this debt is “sorted into categories by FICO score, including sub-prime (less than 620), near-prime (620-660), prime (660 -720) and super-prime (more than 720).”
In 2022, overall consumer-loan losses “rose from modest post-pandemic levels as stimulus programs dried up and inflation increased.”
Faced with stiffer prices for necessities “like gas, groceries and housing, many consumers began burning through excess savings and fewer prepaid their debt balances. Lenders across the board responded by tightening their underwriting policies: Today, new borrowers have average incomes between 10% and 20% higher than before Covid-19 struck.”
The blog post also mentioned that recently, “the percentage of past-due loans to riskier borrowers has begun to flatten, and prepayment rates for sub-prime and near-prime borrowers have fallen to nearly half their pre-pandemic levels.”
Furthermore, the percentage of newer sub-prime and near-prime loans “at least 30 days past due—a historically good indicator of lifetime loan losses—has consistently declined since 2Q 2022.”
Meanwhile, newly originated near-prime collateral “carries a 400-500 bps higher interest rate than similar pools originated a couple of years ago.”
Varun further noted that by comparison, “past-due rates and defaults among prime and super-prime borrowers are still on the rise, and recently originated prime and super-prime paper carries a 200-300 bps higher interest rate than similar collateral did a couple of years ago.”
As mentioned in the update:
“We note that a worsening macro environment could quickly reverse recent favorable trends in the sub-and- near-prime consumer credit markets. In the meantime, we believe investors may want to consider adding extra protection by seeking to purchase assets at lower prices and better aligning their interests with originators through deferred payments or loss protection mechanisms.”