Latest / Market Pulse / How Lenders Can Navigate This Credit Tightening Environment
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- Equifax Market Pulse podcast Ep. 24 katherine doe: Welcome to the Market Pulse podcast. I'm your host, Katherine Doe, a product marketing director here at Equifax for our risk portfolio. Economists have begun ringing the alarm about an impending recession, and as a result, banks are raising rates and tightening lending standards, and many consumers are feeling the squeeze. In today's episode, we'll discuss how lenders' new credit policy changes are impacting consumers. We'll also reveal how lenders can navigate this credit tightening environment. Jesse Harden joins us with insights on both of these topics, and he's a risk advisor here with us at Equifax. Welcome, Jesse. Jesse Hardin: Thanks, Catherine. Glad to be here. katherine doe: Before we begin, let's get a brief economic update from David Fieldhouse, Director of Consumer Credit Analytics at Moody's Analytics. David. All right, thanks, David. Thanks for setting the stage for our discussion today. So Jesse, I'd like to dig a little deeper into labor and consumer spending while we continue to see enough strength in these markets and areas to keep the economy out of recession. Jesse Hardin: Yeah, Catherine, that's a good question. So the worker and consumer have kept the US out of recession so far. If you look at the unemployment rate right now, we're at historically low levels. Let me start over. Yeah, good question, Catherine. So the worker and consumer have kept the US out of recession so far. If you look at unemployment right now, we're at historical lows. Job creation is near all-time highs as of late last year. And really, we've seen strong growth and after the pandemic. And so the economy has been fairly resilient when you factor in the headwinds, you think of a pandemic, geopolitical tensions and inflation higher than we've seen in multiple decades. So the real question like you asked is how long can this last? And so recent labor market data shows that the economy is still creating new non-farm payroll jobs. Additionally, we see in sectors like hospitality, healthcare, government and professional services, we're still moving along. Where we see some pullback is in sectors like manufacturing, construction, and retail trade. And recent layoffs in the tech sectors have hit tech workers hard and those associated geographic areas particularly hard. And so really looking at consumer spending, it's the same story. We've seen the strength of the pandemic. But what we know is that inflation makes it harder for consumers to make their ends meet. Additionally, we've seen that consumers have their savings amount. which we saw build up throughout the pandemic and after the pandemic via stimulus and lockdown, those are starting to decline. So it doesn't take an economist really to see that this mixture is going create a greater burden on the consumer. And as a result, we've seen that some delinquency is starting to spike in sectors like credit card, personal loan and auto. So this poses a real concern then for lenders as the results that they start to see in their portfolios. are impacted based on those delinquencies. And so we are seeing that some of those lenders are starting to tighten access to credit. It can really then create a vicious cycle. So we see that the consumer needs access to credit to continue to purchase, but the stricter credit standards means that it's going limit the lender's exposure. And it's just that vicious cycle of credit return. So... katherine doe: Mm. Jesse Hardin: Recent science, then we see metrics, you know, in consumer spending, like the personal consumption expenditures index, it's really showing signs of moderation. So we're going to really need to watch things like the Fed Senior Loan Officer Survey, which compiles information about whether or not banks are tightening or loosening their credit standards. And we can talk a little bit more about some of those best practices, you know, to identify credit risk, and then also how the consumers can grow in this challenging climate. katherine doe: And you mentioned credit tightening, and that's what I want to ask a little bit more about. Can you tell us a bit about the thought process behind credit tightening and why lenders are concerned about their policies right now? Jesse Hardin: Yeah, you bet. So as lenders begin to see challenges in the economy and things like rising delinquency rates, the natural instinct is that they're going to want to tighten their lending standards so that the lender has less exposure in their portfolio. And this can be exacerbated by events that we see in the recent times, like the banking crisis that we just saw with some of the banks and liquidity issues. And so small and medium-sized banks have really seen a flight of deposits into larger institutions. And that can have a pronounced impact. on the liquidity at those banks. But the good news is that the issues don't seem to be systemic. The reality is there are some pockets in the economy where we're seeing increases in delinquency rates as we spoke about. Again, especially in that credit card scenario and even in auto where we're seeing some of the delinquency rates higher than we had in some of the previous recessionary periods. So the good news though is that the economy is still pretty healthy in terms of the credit climate. So the question then becomes for lenders, how do they balance the decision to tighten with the need to grow organically? I think the last guest you had on the podcast, I was very succinct and put it very nicely when he said, we have to continue to have conversations with customers, continue to serve people and be a little more careful, but probably don't turn away people simply to protect capital. And I think that was a very pointed advice. We've also seen companies that in times of economic downturn and credit tightening, they've grown their portfolio and You know, they've really been smart about it taking the contrarian path. So I think You know their opportunities and it's just a matter of finding those katherine doe: Yeah. Maybe we can talk about the flip side of that for a minute. Can you talk about how this tightening impacts the consumer and what we may expect to see if we continue to see tighter credit? Jesse Hardin: Yeah, sure. So we've already, you know, we've talked about small and medium sized banks, how they're pulling back on credit to preserve balance sheets and liquidity. So let's take an example then looking at credit tightening and the impact it can have on small business. So small businesses, they tend to find credit from smaller institutions, those regional banks, credit unions and medium sized banks, where the credit really flows as a result of the relationship built between the small business and the smaller banks. And we know that the small banks, they have less available cash reserves and they tend to rely heavily on credit lines to fund future growth. Those small banks have been a significant provider of credit to the economy. And it's important really then to understand like the small and medium sized banks, they're responsible for about half of commercial credit lending and about half of consumer lending. So based on this, we know that any pullback that we see in small business lending via credit tightening by the banks is going to have a direct impact on small businesses, especially their ability to grow in the future. Conversely, larger banks, they're benefiting from those deposit inflows and they may not pull back as much. The consumer though, as well, is going to equally end up being impacted during the credit tightening policy. And we know that inflation drove consumers to rely more on their credit products. And so as lending becomes harder to get, consumers are going have less ability to rely on credit products for future purchases. So we may see some pullback in the economy, but it's most likely going start with consumers on the lower end of the credit spectrum that are utilizing that credit to make ends meet. katherine doe: Hmm. So we talked a lot about credit tightening, both what that means for lenders and consumers. What does that mean for areas of opportunity for our lender community? Jesse Hardin: Yeah, another great question. So, you know, overall, I would say that there are absolutely opportunities to find, you know, good new account prospects in times of economic downturn. We've helped customers in all credit sectors accomplish their goals in the face of headwinds. The key to success at a tightening economy is to understand and really look for customers who can manage additional credit. So looking at customers, credit durability is something that can really accomplish that objective. For example, at Equifax, we have a product called Financial Durability Index, which looks at non-FCRI data. Yeah, and I know you've talked about it before. katherine doe: Mm-hmm, yeah. Jesse Hardin: Yeah, so looking at non-FCRI data and looking at the capacity for that customer to handle additional debt. And it's important because there's good credit risks and bad credit risks in every credit score band. So katherine doe: Mm-hmm. Jesse Hardin: What the tool does is it helps us define consumers who are those good credit risks in each score band. So as an example, a 720 credit score may have some customers in that score band that are heavily leveraged and they may perform very differently than other 720 scores. And conversely, there could be some in 660 credit scores who have less leverage. And so The secret really in a tightening environment is to better understand the risk tolerance level, both at the organization for one, and then two is the goals, is understanding the goals for growth in the organization, and then really fully understanding the risk profile, both for new and existing prospects, and understand how those prospects are going handle additional access to that credit. katherine doe: And that's a good plug for additional and alternative data, which we've talked about many Jesse Hardin: Absolutely. katherine doe: times on this podcast. So thanks, Jessi. What else do you think may cause lenders to evaluate or reevaluate their credit policy and strategy with the climate right now? Jesse Hardin: Well, that's interesting because there's no shortage of things to think about. katherine doe: Yeah. Jesse Hardin: You know, I think of it really in terms of maybe a book with three chapters. So I would say chapter one is really driven by policy. You know, the katherine doe: Mm-hmm. Jesse Hardin: Fed has had to act because inflation is causing pain for the consumer. The Fed's job right now is it's tricky though, because they have to figure out how to bring down inflation while they don't break everything else. So really to the crux of your question, you know, in terms of chapter one, and we talk about policy. It's really what lays ahead in the uncertainty of how much the Fed has to react to that high inflation. And so if we start to see cooling in the labor market and we start to see consumer spending fall off, we may see that there's going to be a halt to those federal Fed funds rate increases this year, which we expect. And that's going to, you know, that's going to have the effect of bringing down some of those those those borrowing costs. You know, we could see that there's a, you know, a continuation in consumers being able to keep the economy out of recession. If we look then at chapter two, I would say chapter two is driven by the consumer. And so in terms of what lays ahead for the consumer, it's just the opposite kind of of what we talked about. So it's jobs. Do we see that the labor market continues on its pace? Do we see that consumer spending on things like automobiles and houses continue with the consumer's ability to meet their debt obligations? Intuitively, consumers are more likely to meet their obligations if they're employed. So that employment number is going be really critical to watch moving forward. And then as the consumer faces headwinds, in job losses, if they really start to take hold, then we have to watch the consumer's ability to meet those demands. And that's going be a key area of focus. And then I would say the last chapter of that book is what I would characterize as the unknown. So those are things like the banking crisis that we just saw. It's things like the upcoming debt ceiling battle. or even when the student loan moratorium expires. So katherine doe: and Jesse Hardin: geopolitical tensions, energy prices, it's all those unknowns that are coming through. katherine doe: Thank Jesse Hardin: And the katherine doe: you. Jesse Hardin: reality is there's lots of those events that could happen. So as a lender, I would say that to monitor all three of those chapters and then really keep up to speed on which of those chapters are growing. And that's where we're going continue to see that challenge. katherine doe: Great advice. Thanks, Jesse. Love that it's in chapter format. Thank Jesse Hardin: Yeah, easy katherine doe: you. Jesse Hardin: to access. katherine doe: Yes. Yep. Great. So as we wrap up our discussion, what other best practices might you recommend for lenders or have you recommended in your work as part of our risk advisor group? Just to minimize risk and exposure right now, what are you Jesse Hardin: Yeah, katherine doe: sharing? Jesse Hardin: absolutely. And it's the one I'm most passionate about. So I'm not an economist. I just play one on TV, but katherine doe: Yeah. Jesse Hardin: I would say that, we know it's tough right now to find the right balance in credit policy. So if the policy is too strict, then we know that lenders, they can't reach their growth objectives. And if the policy is too loose, then we know that we have runaway credit losses. So right now we're really encouraging lenders to focus on really key three. three key things. So first we would say the best protection means that you monitor your portfolio. So it sounds very simple, but it's or maybe even too simple to be true, but it's really not. It's understand what your portfolio looks like. And I think some lenders are scared to take a look. So to do this, I think lenders should be looking at, getting access to office credit data. And office simply means it's just not their own data. It's outside data sources. So it could be credit data. It could be some of the alternative data that we talked about. And really access that information through account reviews. I would encourage customers who are already doing account reviews to look at fresher data. Fresher data coming in means that you have a better understanding of how customers are performing on other forms of credit, not just on your own portfolio. And then if you're not doing account review, consider... a semiannual or even a quarterly credit append, just to take a better look at how that customer's performing. And then with account reviews, things to look at. So look at delinquent accounts, look at late payments, look at new charge-offs. You can see changes in debt to income and payment to income ratios as a key driver. And then as well, looking at changes in income. And I think all of those are leading indicators of consumer stress. Next, we'd also recommend looking at any behavioral models that you're using. So, behavior models, they're a great way to understand how likely a consumer is going to act based on what you've modeled to. But you'd be surprised how rarely some model performance gets updated and looked at. So, I would recommend, again, taking a fresh look at behavior models' performance and doing sample validations to ensure that the performance is what we're expecting to see as a lender. And then if not, it might be time to enhance or redevelop those models or start fresh with a new model development. And then finally, what I would say is let's use all the tools available to better understand the credit picture for your prospects or existing customers. And as we said, lenders are playing a critical role in a well-functioning economy and so be open to finding those good prospects, you know, and those that can withstand additional debt, um, who can help the portfolio continue to grow and meet the objectives in that tightening environment. So I'd say those three areas are ones that we would recommend just to every customer that we talked to. katherine doe: Awesome. Thanks, Jesse. Jesse Hardin: Sure. katherine doe: I'm going to add one more in here because it's always my favorite question to ask. I know you Jesse Hardin: Okay. katherine doe: talk to customers all the time and are advising. Do you think that there is anything that you're not being asked in your engagements as a risk advisor that you wish you were asked more or a bit of insight or something that maybe lenders aren't thinking enough about that you would caution them to Jesse Hardin: Yeah. katherine doe: take another look at? Jesse Hardin: Yeah, it's a good question. I would say, you know, Lenders are asking us all the time, you know, what are, what are our peers doing? And katherine doe: Mm. Jesse Hardin: I think that there's, there's always a, you know, a natural curiosity about, you know, our peers looking at data more, are they looking at certain types of scores more? Um, so I would, you know, say that it's, that it's, um, asking for more information from sources like Equifax, you know, reach out and understand, uh, you know, we, We talked to, like you mentioned, we talked to lenders every day about a myriad of, you know, of happenings in their portfolio. So, you know, reach out, reach out to some of the industry trade groups that, katherine doe: Mm-hmm. Jesse Hardin: you know, that have critical information about how that industry is performing. And then I would say, you know, personally, one of the things that I've come across is that there's a lot of talking heads and political punditry out there. You know, we. We laugh about it, but it's certainly it's the case. And so I've told customers that you always have to know the angle that that story is coming out because there's oftentimes a hidden narrative behind that story. And so that's why we tend to look at the raw data because the raw data sometimes, most of the times doesn't lie, but sometimes there's nuances with the data. So really focusing in on what's the source of that information and how do I synthesize who's. who's putting it out. So I think some of that's the, those are the questions that I would be asking myself if I was in their shoes. katherine doe: Great. Thanks for sharing, Jesse. And if our audience might like to follow up with you directly, where might they find you? Jesse Hardin: Yeah, so we've got a nifty email address. It's risk advisors, and that's all one word, at Equifax.com. And so if you get your questions there, we'll be happy to answer them in all industries. katherine doe: Well, thank you again, Jesse. 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