How Lenders Can (and Should) Prep the Balance Sheet for a Downturn
Economists are saying the possibility of a recession this year is close to 70% – an increase from the 65% chance reported in November. The current prediction is more than double what economists forecasted in the middle of last year, according to a Bloomberg survey of economists.
Between inflation and interest rate hikes by the Federal Reserve, the credit market is changing, leading to wider credit spreads and higher loan losses at financial institutions. The credit boom that launched in the wake of the pandemic and subsequent stimulus cash injections is starting to reverse, and many lenders are scrambling to adjust.
How Did We Get Here?
Lenders face increased scrutiny in the current economic conditions and may be forced to weather a more exaggerated downturn soon. As a result, many originators are tightening underwriting. LendingClub, for example, reports tightening its near-prime originations (where borrowers’ credit scores are between 620 and 690) by about 50%.
Lenders are facing an interesting scenario. The weighted average life (WAL) of loans continues to increase as prepayment levels are significantly down. During the pandemic, federal stimulus programs put cash in the hands of consumers, many of whom chose to pay down debt. As U.S. consumer credit improved and consumers enjoyed extremely low rates, the refinance market boomed.
But now, the excess cash from stimulus payments has dried up and rates have increased to levels that don’t accommodate a refinance market. Consumers with less-than-stellar credit are having a harder time repaying loans. Prepayments are at low levels and loans will be on the books for longer. While short-term financing like Buy Now, Pay Later (BNPL) is less affected, longer-term loans are feeling the ripple effect. Everything from auto loans to personal unsecured loans will be impacted, making it essential for lenders to monitor the credit health of current borrowers.
While tightening the belt on underwriting can be beneficial, it’s just as important to assess the credit health of borrowers who are already on the balance sheet.
Importance of Proactive Account Reviews
Conducting “account reviews” to identify potentially impaired or distressed borrowers in advance of delinquency can bolster future collection activity and lower losses. This is especially true in credit cards, where delinquencies are on the rise, as proactive adjustments to line limits can significantly curb losses and improve returns.
A proactive approach to distressed loan servicing is key. It requires the same level of due diligence as new loan origination to identify existing borrowers that may have credit weaknesses. Understanding the complete picture of credit weakness can help lenders reduce credit risk and avoid additional delays in collection by restructuring certain loans earlier and appropriately.
Effective account reviews require accurate, updated, and verified credit data, including:
All borrower debt obligations, including those outside of in-house obligations
Recent and verified income and financial information for borrowers
Accurate and verified valuation of all chattel and real estate collateral where needed
With access to the right credit data, lenders can gain a holistic understanding of current borrowers and more accurately assess where restructuring or collection actions may be needed.
For more information about how Bloom can help you with credit data access and furnishment, reach out today.