Total Finance current cash flow. Trended data now available to lenders on consumer credit files provide the ability to assess consumers’ available cash flow based on how much they are paying each month above the minimum due amounts on their debt obligations. A consumer with required minimum monthly credit card payments of $100 who is actually making payments of $400 may have $300 of excess cash flow that she could redirect to offset the payment shock. This insight enables the comparison between payment shock amount and a consumer’s available cash flow. We define a person’s capacity to absorb (CtA) as the difference between excess payments on loans and the size of the payment shock— calculated on a monthly basis: CtA = Excess Payment Amounts – Payment Shock As you can see in the accompanying “Illustration of monthly CtA calculation” chart, two consumers can have the same payment shock amount, but may have different capacities to absorb that shock, simply because of different cash flow situations to begin with. In the case of the second consumer shown above, CtA is negative, meaning this consumer would have challenges meeting the increased debt repayment requirements. For each anonymized individual in
the exposed population defined above, we calculated his or her CtA amount using this method and found that with a 0.25-point interest rate increase, 718,000 consumers might have difficulty absorbing the payment shock. An additional 253,000 consumers might not be able to absorb the shock if the rate were to rise by a full percentage point. Among these consumers, more than 650,000 with strong credit—those whose credit scores are prime or better—may have difficulty absorbing such a payment shock.
What this means to lenders This is especially compelling news for lenders as hundreds of thousands of borrowers currently believed to be lower risk may suddenly become risky with an increase in interest rates and payment obligations. While lenders normally expect subprime consumers to be riskier, this potential change in the risk profiles of prime or better consumers may come as an unpleasant surprise. These findings are simulation results and reality might turn out to be somewhat different. First of all, cash flow based on credit files is a conservative measurement and does not take into consideration potential savings or other sources of
cash the consumers could draw on to help mitigate the payment shock. In addition, rate increases typically happen during “good times” when the economy is expanding, which usually benefits consumers’ cash flow through improved employment prospects and earnings. Finally, even though we identify nearly one million consumers who might struggle under a one-point rate hike, rate increases generally occur in 0.25-point increments; it could take a number of quarters to reach a one-point rate increase, giving consumers and lenders more time to adjust and adapt. Nevertheless, lenders may benefit from evaluating their own portfolios in a similar manner to determine who among their customers might be vulnerable to a payment shock, and work with those customers to ensure their accounts remain in good standing. Jason Wang is the director of research and consulting for TransUnion, where he is responsible for leading research projects and industry analysis in Canada. Prior to joining TransUnion, Wang held management roles at American Express, CIBC and Citigroup. Jason received his MBA from New York University and his Bachelor degree in Physics from Peking University. He is a CFA charter holder.
Illustration of monthly CtA calculation
Excess payments
Payment shock
CtA
Consumer 1
$1,000
$300
$700
Consumer 2
$100
$300
-$200
Number of consumers (in thousands) whose cash flows may not be enough to offset a payment shock
Risk segment (score)
0.25-point interest rate increase
One-point interest rate increase
Super Prime (830–899)
239
298
Prime Plus (780–829)
112
163
Prime (700–779)
134
193
Near Prime (600–699)
132
184
Subprime (300–599)
101
133
Total
718
971
Fall 2016
CANADIAN TREASURER
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