SECTOR IN-DEPTH
15 JULY 2015
ANALYST CONTACTS
Greg O'Reilly 4420-7772-8673 AVP-Analyst
Aishwarya Dahanukar 4420-7772-1495 Analyst
[email protected] Paula Couce Iglesias 4402-7772-1420 Associate Analyst
ABS - UK
Rising Consumer Debt Is Increasing Risk in UK Credit Card Pools
Executive Summary
Risk in UK credit card pools is increasing as a result of growing unsecured consumer debt, which leaves consumers more vulnerable to economic shocks. Lower interest rates are partly driving consumer debt by making it more affordable, hiding the risk to consumers with potentially negative long-term consequences. Nonetheless, we expect credit card pool performance to remain stable over the next year owing to market trends and the strong credit quality of the pools we rate.
Unsecured consumer debt is rising, leaving borrowers increasingly vulnerable to economic shocks
UK credit card pools are becoming riskier as consumers take on more unsecured debt to maintain spending. As exhibit 1 shows, consumer spending has surpassed pre-crisis levels at a time of significantly lower wage growth and declining savings rates.
Exhibit 1
Declining Savings and Wages Cannot Pay for Rising Consumption Consumer spending now above pre-crisis levels
Source: Bloomberg; UK Office of National Statistics (ONS); Eurostat
A consequence of these trends has been an increase in the rate of unsecured lending to consumers. Exhibit 2 shows how consumer lending growth has jumped to nearly 7% year over year since 2012, when it remained below 1%. This increased rate of growth is credit negative for UK credit card pools because consumers will have less capacity to repay their card balances as consumer debt increases faster than wage growth.
Exhibit 2
Consumer Lending has Grown Rapidly Since Q4 2012 Growth Coincides with Increased Consumer Spending
Source: Bloomberg, Moody's Investors Service
Reliance on interest-free periods to finance credit card debt has increased affordability risk in credit card pools
The increased length of the interest-free period offered to borrowers who transfer their balance to a new credit card provider (balance transfers), is helping to fuel the growth in the card balances of UK consumers and hiding the risk this implies by making minimum payments more affordable.
At the beginning of 2013, the best balance transfer offers provided a two-year interest-free period on the transferred balance, whereas the current best offers allow for three years of interest-free credit. The ability of borrowers to take on interest-free debt has incentivised them to take on more credit card debt. Despite the seasonal dip in card balances at the beginning of the year, we expect the upward trend in card debt shown in Exhibit 3 to continue.
The risk is that if consumers do not repay the transferred balances before the end of the interest-free period and the debts begin to accrue interest, consumers will struggle to afford the higher levels of debt they have taken out since 2013. This “affordability risk” now appears a likelier scenario than it did previously. Since 2012, the increasing percentage of interest-free card balances has offset rising card debt. But as Exhibit 3 shows, while card balances continue to grow, the proportion of interest-free balances is now stabilising. The result, which we estimate in Exhibit 4, will be increased monthly card payments.
Exhibit 3
Percentage of Interest-Free Balances has Stabilised while Total Card Debt Keeps Growing Higher absolute amount of interest accruing balance increases average minimum payments
Exhibit 4
We Expect Average UK Minimum Card Payments to Increase Higher payments will be driven by higher credit card debt
Source: British Bankers' Association, Moody's Investors Service
Exhibit 4 shows a projection for how average minimum credit card payments, after falling consistently since 2010, are likely stabilising and will slowly rise if card debt continues to increase.1
Despite increased risk, credit card pool performance will remain stable over the next 12 months
Despite consumers’ growing indebtedness, delinquency performance of the credit card pools we rate will remain stable over the next 12 months, reflecting current market trends and the credit strength of the pools. Exhibit 5 shows that delinquencies stabilised in 2014 at historically low levels after declining year on year since peaking in 2009.
Exhibit 5
Credit Card Total Delinquencies Delinquencies stable at historically low level
Source: Moody's Investors Service
We think delinquencies have stabilised partly because they are at a sufficiently low level to have reached a natural floor given the structure of the UK economy due to natural attrition in employment and the repayment capacity of card users. We also believe the stable delinquency levels reflect the affordability trends highlighted in Exhibit 4. Because a consumer only needs to make the minimum payment to avoid delinquency, lower minimum payments have supported lower delinquencies by cutting the threshold consumers need to pay to remain current on their credit card payments.
The increase in minimum payments we anticipate in the next 12 months is unlikely to have a meaningful impact on credit card pool performance. As Exhibit 4 shows, minimum payments still remain low compared with previous years, and although minimum payments are likely to trend upward, the increase will be relatively slow. The slow rate of increase is a result of the length of interest- free period offers available, and the ability of good-quality borrowers to transfer their balances to another account to maintain interest-free balances. Low delinquency rates are also supported by low UK unemployment that is expected to continue, and low interest rates that are only expected to rise slowly in Moody's base case scenario.2
Performance in Moody's rated credit card pools will also remain stable because the credit quality of the securitised debt is stronger than the average UK credit card debt. All of the outstanding pools we rate are highly seasoned, typically with average seasoning of nearly 10 years or more. All of our pools have been originated by one of the main high street banks, which benefit from the long-term and consistent information they have on customer behaviour across other product lines and from their long-standing presence in the market.3 The growth in consumer lending since mid-2013 (Exhibit 2) has coincided with a period in which the rate of growth of high street banks' card balances has been overtaken by the growth of non-high street bank lenders, which is reflected by the higher total card market growth compared to the high street banks since the start of 2014 (Exhibit 6). Because high credit card growth rates imply higher average risk, we think recently originated pools of non-high street bank lenders is more at risk from an economic shock than those of the high street banks.
Exhibit 6
Total Credit Card Market has Been Growing Faster than High Street Banks' Credit Card Books Growth is higher in the non-high street bank credit card sector
Source: British Bankers' Association, Moody's Investors Service
Credit card performance is also supported by the improved underwriting standards of issuers since the crisis, which lowers the likelihood of a return to the delinquency levels reached in 2009. Since 2011, issuers have voluntarily agreed to adhere to a code of practice that requires a higher level of lending standards than some market participants had previously operated under, thereby reducing risk by limiting potential for poor origination practices. The code includes requirements that payments must be allocated to the most expensive part of the credit card balance first, the minimum payment must be sufficient to repay at least 1% of the principal balance, and also requires issuers to undertake appropriate checks to assess the consumer’s ability to repay.
Moody's Related Research
Rating Methodology Primary:
» Moody's Approach to Rating Credit Card Receivables-Backed Securities, June 2015 (SF409592) Sector Comments:
» Challenger Entrants' Credit Card Pools Are Riskier Than Those of High-Street Banks, April 2015 (SF1003781)
» Senior European ABS and RMBS Tranches Will Remain Insulated From Principal Losses, June 2015 (SF1005572) Index:
» UK Credit Card Indices - May 2015 (SF412670)
To access any of these reports, click on the entry above. Note that these references are current as of the date of publication of this report and that more recent reports may be available. All research may not be available to all clients.
Endnotes
1 We assumed all minimum payments required only 1% of principal to be paid per month, 18% APR on interest accruing balances, and that average card balances would grow at an annualised 2.5% in the 12 months from May 2015. We assume 2.5% card balance growth reflecting the rate of annual growth in outstanding credit balances over the last twelve months based on BBA data and 18% APRs based on recent average effective rate credit cards data from the Bank of England.
2 For more discussion on the factors driving Moody's interest rate expectations please see “Lower oil price fails to spur global growth” published February 2015.
3 Our definition of high street banks follows that used by the BBA, which refers to Santander UK Group, Barclays Group, HSBC Bank Group, Virgin Money Plc, Lloyds Banking Group and The Royal Bank of Scotland Group. For more research on how High Street bank pools differ from other originated credit card debt, please see “Challenger entrants credit card pools are riskier than those of High Street banks” published April 2015.
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