Report: A Deeper Understanding of Payment Shock Dynamics

A Deeper Understanding of

Payment Shock Dynamics

Nidhi Verma

Senior Director, Financial Services Research and Consulting

TransUnion

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What is a payment shock?

A change in your payment obligations that you cannot control.

© 2016 TransUnion LLC All Rights Reserved | 3

1. Dynamics of interest rate payment shock

2. Impact of interest rate payment shock within a consumer’s wallet

3. Implications for consumers and lenders

In this session, we will review:


Interest rates have been at their lowest since the mid-1980s

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12-mo LIBOR

U.S. Prime rate

Effective FederalFunds Rate

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Source: Federal Reserve Bank of St. Louis

Early 1990s

recession

Early 2000s

recessionGreat recession


Critical questions to address around interest rates are:

1. Will interest rates rise again?

2. If yes, when will they rise?

3. How much will they rise in near-term?

4. How will a rise in interest rates impact consumers

and lenders in the consumer credit market?

Yes.


Here are some business questions that we will answer to provide

insights on the impact of a rise in interest rates

1. How many consumers in the United States have variable-rate credit?

2. How many consumers are exposed to a payment shock from a rise in

interest rates on a variable-rate product?

3. How does the monthly debt payment obligation change for those

consumers?

4. How many consumers have the capacity to absorb a payment shock?

5. What is the incremental consumer risk associated with various rises in

interest rates?


To estimate a payment shock from interest rate volatility, we need to

take a step-by-step approach

Step 1. Identify variable-rate credit products

Step 2. Estimate APR for variable-rate credit products

Step 3. Identify consumers impacted by a change in variable APR

Step 4. Calculate a payment shock for impacted consumers

Step 5. Identify consumers who do not have the capacity to absorb the estimated shock

Q4 2015


Here is a distribution of variable-rate consumer credit products

Distribution of consumer credit in the U.S.—Q4 2015

0%

20%

40%

60%

80%

100%

Mortgage Auto Credit Card HELOC Personal loansScenario 1

Personal loansScenario 2

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Source: TransUnion consumer credit database

Variable balances

in $ billions $327B $277B$0B $445B $0B$776B

Variable

Fixed


80137


Finding 1: There are 134 to 137 million consumers who are exposed

to a payment shock arising from a rise in interest rates

Exposed

(have variable-rate credit

products)

83134

Scenario 1 Scenario 2

Not exposed

(do not have variable-rate

credit products)


We are now at step 2 of the approach






Q4 2015


We have a reasonable approach to estimating APR for each

variable-rate credit product


Actual APRs for adjustable-rate mortgages were provided

by our partner, CoreLogic

We leveraged CreditVision® trended data to calculate APR

using the last 6 months’ minimum payment due and

average balance (for every card in a consumer’s wallet)

We developed an algorithm using payment due and

current balance data. For loans that have hit end-of-draw,

we assumed a 15-year amortization period

We developed an algorithm using payment due,

originating loan amount, term and current balance data

This approach was validated

against actual data for a

major credit card issuer with

strong results

Q4 2015


Step 3: Let’s identify those consumers who are impacted by a

change in the APRs we estimated

Q4 2015







Not all consumers with a variable-rate credit product are impacted

by a change in APR

Impacted: ARMs that will be adjusted in 2016

Not Impacted: ARMs that will be adjusted in 2017 onwards

Impacted: Revolvers

Not Impacted: Transactors and consumers with an APR of 29.99%

Impacted: All lines

Impacted: Under scenario 2, all loans

Not Impacted: Under scenario 1, all loans

Q4 2015


Scenario 1: We believe that 64% of consumers will be impacted from a

change in variable APRs, assuming all personal loans are fixed

% of consumers impacted by change in interest rates


64%77% 75%

64%52%

64%

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Subprime Near prime Prime Prime plus Super prime Total

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ers

Not impacted

Impacted

VantageScore © 3.0 risk ranges

Subprime = 300–600, Near prime = 601–660, Prime = 661–720, Prime plus = 721–780, Super prime = 781+


Scenario 2: We believe that 68% of consumers will be impacted from

change in variable APRs, assuming all personal loans are variable

% of consumers impacted by change in interest rates


71%82% 79%

68%54%

68%

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100%

Subprime Near prime Prime Prime plus Super prime Total

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ers

Not impacted

Impacted




Finding 2: Of the exposed consumers, 87 to 92 million would be

impacted by an interest rate payment shock


13087

Not impacted by a

payment shock

Impacted by a

payment shock

Scenario 1 Scenario 2

12592


We can now begin our simulation for change in payment obligations

at a consumer level

Q4 2015







Scenario 1: Our simulation indicates that 85% of impacted consumers

would have a monthly payment shock < $10 for a 25 bps increase in rate

0%

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50%

$1 $3 $5 $7 $9 $11 $13 $15 $17 $19 $21 $23 $25 $27 $29 $31 $33 $35 $37 $39 $41 $43 $45 $47 $49


Percentage distribution of consumers by change in payments – personal loan scenario 1

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ers

Change in monthly payment obligation

Average change in

monthly payments

$6.33



Super prime

Prime plus

Prime

Near prime

Subprime

Total


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20%

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40%

50%

$1 $3 $5 $7 $9 $11 $13 $15 $17 $19 $21 $23 $25 $27 $29 $31 $33 $35 $37 $39 $41 $43 $45 $47 $49

Scenario 2: Our simulation indicates that 84% of impacted consumers

would have a monthly payment shock < $10 for a 25 bps increase in rate


Percentage distribution of consumers by change in payments – personal loan scenario 2

Pe

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ers

Change in monthly payment obligation

Average change in

monthly payments

$6.45



Super prime

Prime plus

Prime

Near prime

Subprime

Total

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We ran multiple simulations for each scenario.

Following are the results for a more risk-conservative

scenario, i.e. all personal loans are variable


Finding 3: With a 25 bps rise in interest rates, 99% of consumers who are

impacted will have a payment shock of less than $50 per month

Scenario 2: 25 bps rise in interest rate and change in monthly payments

(for consumers who are impacted)


[$1–$10) [$10–$25) [$25–$50) [$50 or more)

Super prime 91% 6% 2% 1%

Prime plus 82% 14% 3% 1%

Prime 77% 18% 4% 1%

Near prime 74% 20% 5% 1%

Subprime 84% 12% 3% 1%

Total 82% 13% 4% 1%




Finding 3: With a 50 bps rise in interest rates, 96% of consumers who are

impacted will have a payment shock of less than $50 per month




[$1–$10) [$10–$25) [$25–$50) [$50 or more)


Prime plus 64% 24% 8% 4%

Prime 57% 27% 11% 5%

Near prime 54% 27% 13% 6%

Subprime 70% 19% 8% 3%

Total 67% 21% 8% 4%




Finding 3: With a 100 bps rise in interest rates, 88% of consumers who

are impacted will have a payment shock of less than $50 per month




[$1–$10) [$10–$25) [$25–$50) [$50 or more)


Prime plus 42% 29% 17% 12%

Prime 35% 29% 20% 16%

Near prime 33% 27% 21% 19%

Subprime 52% 23% 14% 11%

Total 46% 26% 16% 12%



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Can we identify consumers who do not have the

capacity to absorb a payment shock?


At the final step of our analysis…

Q4 2015







To understand a consumer’s capacity to absorb an interest rate payment

shock, let’s recall our Aggregate Excess Payment (AEP) metric

MPD

Payment

$1,000

$2,000

MPD

Payment

$50

$125

Aggregate Excess Payment (AEP) is defined as

total payments – total minimum due

AEP = $1,000 AEP = $75

AEP can be calculated over any past timeframe up to the previous 30 months using CreditVision data.

For our analysis, we calculated AEP across all credit products.


Next, by taking into account the estimated payment shock from a

rate increase, we can calculate a consumer’s capacity to absorb

Payment shock

AEP

$500

$2,000

Payment shock

AEP

$300

$100

Capacity to Absorb (CtA) is defined as

AEP — Payment shock

CtA = $1,500 CtA = ($200)


We can now identify consumers who have a negative capacity to

absorb a payment shock, among those impacted

Percentage distribution of impacted consumers—25 bps rise in interest rates


Capacity to absorb

Negative Positive

Super prime 1% 99%

Prime plus 2% 98%

Prime 5% 95%

Near prime 13% 87%

Subprime 50% 50%

Total 10% 90%



Finding 4:

9.3 million consumers do not appear to have the

capacity to absorb a 25 bps rise in interest rates.


As expected, if interest rates rise further, the number of consumers

with negative capacity to absorb is expected to increase


Percentage of impacted consumers who have a negative capacity to absorb

Increase in interest rate simulation

25 bps 50 bps 100 bps

Super Prime 1% 1% 1%

Prime Plus 2% 3% 4%

Prime 5% 6% 9%

Near Prime 13% 15% 18%

Subprime 50% 52% 54%

Total 10% 11% 13%



Finding 5:

If interest rates rise by 100 bps,

an incremental 2.5 million consumers may

have a negative capacity to absorb.


To summarize:


Number of consumers 25 bps rise in

interest rates

100 bps rise in

interest rates

Impacted by an interest rate

payment shock and have a negative

capacity to absorb the shock

7.9 million to

9.3 million

10.2 million to

11.9 million

Of those impacted consumers who

are prime or better

1.2 million to

1.5 million

2.3 million to

2.7 million

The ranges represent the two scenarios: all personal loans fixed versus variable

Prime or better includes:

VantageScore © 3.0 risk ranges of Prime = 661–720, Prime plus = 721–780, Super prime = 781+


How can you leverage this information for smarter decisions?

• There is a clear and material risk from interest rate payment shock

• However, that impact is not as widespread as some fear, and can be identified effectively

at the consumer level

• Perform portfolio analysis to understand your exposure on a consistent and ongoing basis

• Identify consumers with a positive capacity to absorb a payment shock as part of your

acquisition strategy

• Utilize this approach to reduce rate vulnerability among your customers and prospects

• Educate consumers about interest rate risk and how to manage their payments

responsibly

Economy & Finance

Report: A Deeper Understanding of Payment Shock Dynamics