European credit risk outlook

Transcription

1 February 2011 European credit risk outlook Best practices in retail financial services more information on and

2 Contents 03 Introduction 04 Summary 05 Results - 05 Credit delinquencies - 08 Credit supply and demand - 13 Interest rates - 14 Affordability - 15 Regulatory effects 17 Respondents profiles

3 european credit risk outlook Introduction These are challenging times for banking. The pressure for banks to extend credit to individuals and small businesses in order to fuel economic growth is matched by a new caution on the part of regulators hoping to stave off future banking crises. Banks too are becoming more cautious in their risk appetites because of the more aggressive capital requirements of Basel III. Since the October 2008 liquidity crisis, business news headlines have addressed factors such as economic stability, interest rates, credit access, interchange fees, regulation on fees, capital reserves and provisions, delinquency, home foreclosures, defaults and insolvencies. Weekly, the IMF and World Bank are quoted about restructuring the banking culture and introducing financial stability not in the Third World, but right here in Europe. Pundits from central banks make headlines almost daily, while the ECB, the Basel Committee and the G10 economic supervisors are quoted to lead off the 24-hour news cycles at half-hourly increments. The scrutiny under which credit risk management must function is unprecedented. These market forces form the background of this report, the first European credit risk outlook. Together, FICO and Efma (European financial marketing association) have turned to thought leaders at top banks throughout Europe to gather a forward-looking picture of the credit market. Unlike many reports, which provide a deluge of data confirming today s banking picture, we asked just a few questions to build a timely snapshot. In particular, we were keen to learn what risk managers see in terms of credit supply and demand, as well as to understand what risk managers see as the greatest challenges to credit supply growth and lending profitability. Findings from this survey will in turn help to inform the Risk Managers Advisory Council, a group of European risk professionals formed by Efma and sponsored by FICO, and to enliven discussion at the inaugural Efma Credit Risk and Debt Management Conference: Managing Change in Consumer Credit and Debt Behaviour in Paris, in February We are grateful to all the executives from 32 countries representing organisations both large and small who took the time to participate in this inaugural survey. Over the coming year, watch for new reports from Efma and FICO on these changing market conditions. Mike Gordon Vice President, EMEA FICO Patrick Desmarès Secretary General Efma 3

4 Summary FICO and Efma conducted a survey of credit trends in November and December 2010 with risk professionals in Europe. The aim of this survey, which will be conducted quarterly, is to provide a forward view of potential growth and challenges in the granting of consumer credit. Participants included credit-granting institutions ranging from local banks to global institutions. Representatives from 32 European countries and 108 companies responded to the initial survey. The survey asked participants for their forecast over the next six months. Results of this survey show: Across Europe, risk managers expect relative improvement in auto loan performance and credit card performance, with significantly less optimism for mortgage and small business loan delinquency. A deterioration in overdraft performance coupled with the deterioration in small business performance suggests continuing sluggishness, which is markedly worse in some geographies. Risk managers foresee increases in credit demand, but less growth in credit supply, suggesting a credit gap similar to that observed in the United States. Regulations, including Basel III, will likely cause lenders to tighten credit supply to consumers and small businesses, which may challenge economic recovery and create unintended consequences for monetary policy. This report shares the key findings for all respondents, and in addition breaks out specific responses by three regions: DACH (Germany, Austria, Switzerland), Iberia (Spain and Portugal) and the United Kingdom/Ireland. We invite readers to discuss this report online at 4

5 european credit risk outlook Results Credit delinquencies Looking at the banking industry in your region, over the next six months, do you expect: The level of residential mortgage delinquencies (of 90 days or more) to The level of credit card delinquencies to The level of auto loan delinquencies to The level of small business loan delinquencies to The level of overdrafts to 0% 10% 20% 30% 40% 50% Respondents are more optimistic about auto lending than about other consumer and small business products. Only 36% of respondents expect to see a rise in auto delinquency, while 20% expect a decrease in delinquency. More disturbingly, respondents are relatively pessimistic about delinquent overdrafts tied to current accounts. Less than 10% of respondents expect to see delinquency levels lessen, while nearly half (48%) expect delinquencies to worsen. This is a worrisome supposition, as the delinquency of the current account overdraft obligation signals a cash flow problem for the consumer. This may have knockon delinquency impacts for payments made toward other credit obligations, and may be the most visible impact of long-term unemployment and reduction in public support payments. Respondents were relatively pessimistic regarding small business loans, as only 17% anticipate a decrease in delinquency, while nearly half (47%) of respondents expect delinquency to increase. These factors bode poorly for the overall ability of the small business sector to generate jobs and stimulate economic stability and growth. With respect to mortgages, while about 14% of respondents expect to see delinquency (defined as 90 or more days past due on the mortgage obligation) decrease, 69% expect to see mortgage delinquency stay the same or worsen. This calls into question the idea of a housing segment recovery, and when coupled with the prognosis on overdrafts and the pessimism on small business performance, suggests that the European economy will continue to struggle. If respondents responses factored in withdrawal of stimulus programmes and reductions in fiscal spending set for many European member states, then these predictions are perhaps not quite as dire. 5

6 Given the mixed acceptance of credit cards across Europe, and the historical susceptibility of credit card delinquencies to variations in interest rate, it is not surprising that 47% of respondents expect card delinquencies to worsen. One might assume that the 20% of responders who expect reduction in card delinquencies may be looking at a return to spending by better-quality credit consumers, or a withdrawal from usage by certain card issuers after rates increase. It is also possible that card issuers expect a return to higher utilization that would not necessarily eliminate delinquent balances, but which could reduce the delinquency rate based on higher balances in the denominator of the delinquency rate calculation. DACH Looking at the banking industry in your region, over the next six months, do you expect: The level of residential mortgage delinquencies (of 90 days or more) to The level of credit card delinquencies to The level of auto loan delinquencies to The level of small business loan delinquencies to The level of overdrafts to 0% 10% 20% 30% 40% 50% 60% DACH respondents (Germany, Austria, Switzerland) are significantly more pessimistic on small business, and markedly more optimistic on consumer obligations. For instance, a significantly greater proportion of DACH respondents 60% expect delinquency by small businesses to worsen. Yet card delinquencies are expected to improve by 44% of respondents, auto delinquencies by 60%, and 40% of respondents expect improvements in overdraft. 6

7 european credit risk outlook Iberian peninsula Looking at the banking industry in your region, over the next six months, do you expect: The level of residential mortgage delinquencies (of 90 days or more) to The level of credit card delinquencies to The level of auto loan delinquencies to The level of small business loan delinquencies to The level of overdrafts to 0% 20% 40% 60% 80% 100% Respondents from the Iberian peninsula (Spain/Portugal) reflect the generally poor economic conditions still in place in this region. No Iberian respondents expect delinquency to improve in any lending category, while at least 90% of respondents in every category expect delinquency to further worsen. UK and Ireland Looking at the banking industry in your region, over the next six months, do you expect: The level of residential mortgage delinquencies (of 90 days or more) to The level of credit card delinquencies to The level of auto loan delinquencies to The level of small business loan delinquencies to The level of overdrafts to 0% 10% 20% 30% 40% 50% 60% Respondents from the UK and Ireland also can be characterized as more pessimistic regarding both consumer and small business delinquency than the average response across Europe. For instance, more than 60% of respondents expect small business delinquency to worsen, and no consumer credit portfolio is expected to worsen by less than 35% of respondents. Overdrafts are expected to increase by 43% of respondents, while expected to decrease by only 7% of respondents. Strikingly, however, while 50% of respondents expect credit card delinquency to worsen, more than 35% of respondents expect to see delinquency by cardholders improve. This suggests that cards are the area of greatest diversity in risk appetite and risk policy for the UK market. 7

8 Credit supply and demand Looking at the banking industry in your region, over the next six months, do you expect: The approval criteria for common credit & loan products to The average balance on credit card accounts to The volume of consumer The aggregate amount of credit requested by consumers to The approval rate of consumer The amount of consumer credit extended by lenders to The volume of small business The aggregate amount of credit requested by small businesses to The approval rate of small business The amount of small business credit extended by lenders to 0% 10% 20% 30% 40% 50% 60% Credit supply has already tightened in many European markets, as lenders have responded to difficult economic times and rising unemployment. At the same time, demand for credit has also contracted, and numerous studies have indicated a consumer shift to use of debit products. With this background, respondents indicated that while the amount of credit provided is expected to rise, demand for credit is expected to rise faster, a trend that is more pronounced among small business borrowers. Consumers and business owners are likely to perceive a credit gap for some time. 8

9 european credit risk outlook While 62% of respondents say that consumers will request more credit, only 47% believe the amount of credit extended will increase, and 17% believe it will decrease. However, 39% foresee a rise in the approval rate for credit. The fact that demand will exceed supply is in some ways heartening, as it suggests that consumer spending and risk appetites may be regaining strength after a period of relative disinterest. While a variety of factors, including delinquency expectations and reserve requirements, may be inhibiting supply, respondents are effectively indicating a return to cautious growth. With respect to small business credit, 55% of respondents expect an increase in the total amount of credit requested by small businesses. However, only 35% of respondents see an increase in the approval rate for small business credit, and only 39% see the total amount of credit extended to rise. As on the consumer side, demand may outstrip supply. Given the precarious condition of small businesses in many industry sub-categories and the expectations for worsening small business delinquency, this likely reflects the on-going weakness of small business repayment ability. It is here that the risk appetite and economic growth objectives come into greatest conflict. A more liberal lending policy aimed at helping small businesses to meet their liquidity needs would be desirable for stimulating growth. Yet long-term unemployment and relatively weak consumer demand rightly make banks cautious about lending into the small business sector, especially in trading categories associated with historically high failure rates. 9

10 DACH Looking at the banking industry in your region, over the next six months, do you expect: The approval criteria for common credit & loan products to The average balance on credit card accounts to The volume of consumer The aggregate amount of credit requested by consumers to The approval rate of consumer The amount of consumer credit extended by lenders to The volume of small business The aggregate amount of credit requested by small businesses to The approval rate of small business The amount of small business credit extended by lenders to 0% 10% 20% 30% 40% 50% 60% 70% 80% Despite the relative pessimism expressed by DACH respondents concerning delinquencies, nearly 80% (78%) of DACH respondents expect the amount of consumer credit extended to rise, while 55% of respondents expect small business credit extended to increase. Approval criteria are expected to be relaxed by 44% of respondents. Half of respondents in DACH expect consumer credit balances to rise. This suggests that there may be a credit supply surplus unique to DACH, and that improvement in borrowing demand would be welcome. 10

11 european credit risk outlook Iberian peninsula Looking at the banking industry in your region, over the next six months, do you expect: The approval criteria for common credit & loan products to The average balance on credit card accounts to The volume of consumer The aggregate amount of credit requested by consumers to The approval rate of consumer The amount of consumer credit extended by lenders to The volume of small business The aggregate amount of credit requested by small businesses to The approval rate of small business The amount of small business credit extended by lenders to 0% 10% 20% 30% 40% 50% 60% 70% Given the economic conditions and delinquencies expectations respondents expressed for the Iberian peninsula, it is no surprise that respondents predict little improvement in either supply or demand -- for both consumer and small business credit. 11

12 UK and Ireland Looking at the banking industry in your region, over the next six months, do you expect: The approval criteria for common credit & loan products to The average balance on credit card accounts to The volume of consumer The aggregate amount of credit requested by consumers to The approval rate of consumer The amount of consumer credit extended by lenders to The volume of small business The aggregate amount of credit requested by small businesses to The approval rate of small business The amount of small business credit extended by lenders to 0% 10% 20% 30% 40% 50% 60% 70% UK and Ireland respondents appear to be more aligned with expectations for a blend of growth and caution around consumer credit than those elsewhere in Europe, and especially more than either the DACH or Iberian respondents. The number of respondents expecting growth in credit extension (46%) is slightly bigger than the portion of respondents expecting increased demand for consumer credit applications (38%). This suggests that supply and demand for consumer credit are fairly balanced in the UK and Ireland. By contrast, the UK remains pessimistic regarding small business credit, with 58% of responders expecting growth in credit demand by SMEs, and only 33% of responders expecting growth in credit extended to SMEs. 12

13 european credit risk outlook Large credit economies: This breakout of some of the larger consumer credit economies suggests two things 1. A significant gap in credit availability for SMEs should be expected, given the pessimism and expectation for increased delinquency expressed by the majority of respondents. 2. Growth and cautious optimism are more characteristic of banks operating or headquartered in the smaller nations of Europe. These countries tend to have consumers who are less highly leveraged and which can better manoeuvre in tight economies, due to the lower demand of credit obligations on their household income. Interest rates Nearly 45% of respondents across Europe expect interest rates to rise (DACH 40%, the Iberian peninsula 100%, UK and Ireland 38%) while only 11% of respondents expect rates to fall in the coming period. Rising interest rates may on the one hand attract more deposits, yet on the other hand may also cause an increase to payment amounts for any variable-rate credit obligations. This would seem to have the greatest impacts on overdraft and credit card obligations, as reflected in survey responses on delinquency. Interest rates In your region, do you expect: Interest rates for consumer credit to 0% 10% 20% 30% 40% 50% 13

14 Affordability Given more extensive regulations in markets such as the UK requiring that lenders assess whether borrowers can afford new credit, the survey asked whether lenders had such measures in place. A whopping majority (83%) said they did, and 14% indicated they plan to adopt such measures. This was largely true across the three largest credit economies UK and Ireland (83%), DACH (78%) and the Iberian Peninsula (70%). The interesting challenge for lenders will be the degree of precision expected by regulatory supervisors in the affordability assessment, which may require steps beyond traditional calculation methods of debt-to-income ratios. Markets like South Africa, which have had formal affordability requirements for several years, have relied heavily on the use of credit bureau data and credit bureau scores to ascertain the extent of a consumer s external credit holdings. The challenge for lenders operating in markets with full (positive and negative) credit bureau reporting like that in South Africa may be markedly different than for those markets with negative-only credit bureau reporting, which includes many states across Europe. Variance in national focus on affordability may also have the unintended consequence of disrupting the competitive equilibrium that the European Commission would like to see in harmonizing the availability of credit and costs for credit products across the EU. Is your bank: Adopting measures of affordability when extending credit offers to consumers? No, we have no plans to do this We are researching this Yes, we have firm plans to start in the next 6 months Yes, we do this now 0% 20% 40% 60% 80% 100% 14

15 european credit risk outlook Regulatory effects Looking ahead to 2011, do you expect: Basel III regulations will cause consumer lending to: Regulations designed to protect consumers will cause consumer lending to: Remain the same (no impact) New banking regulations will cause profits from retail consumer and SME portfolios to: 0% 10% 20% 30%40% 50%60% Risk managers clearly indicated that some of the tightening in credit supply will be due to regulations, including Basel III requirements for higher capital reserves. One-third of respondents said Basel III would cause consumer lending to decrease, compared with just 9% who foresaw an increase. This result coincides with reports indicating that half of the deficit in capital reserves resides with banks in Europe, and that compliance in the short term will divert investment from growth activities. More than half (52%) of respondents said consumer protection regulations would lead to a decrease in consumer lending. This phenomenon has already been observed in the US, where the CARD Act designed to reduce costs for consumers by restricting pricing options for issuers has caused one lender to eliminate 15% of its current card portfolio in order to maintain profitability. This is the risk of protectionist regulation despite beneficial intent, the unintended consequence may be to reduce credit access for the consumers and small businesses that need it. Respondents from the DACH region expect consumer protection to improve credit availability. This is likely the outcome of consumer credit protections unique to DACH, and has likely influenced the DACH response suggesting credit availability will outstrip credit demand. 62% of respondents said new banking regulations will reduce profits from consumer and SME credit portfolios. A long-term depression of banking profitability may undermine the stability of the banking sector and drive long-term disinvestment from banking stocks that were previously viewed as a blue-chip investment. 15

16 DACH Looking ahead to 2011, do you expect: Basel III regulations will cause consumer lending to Regulations designed to protect consumers will cause consumer lending to New banking regulations will cause profits from retail consumer and SME portfolios to 0% 20% 40% 60% 80% Iberian peninsula Looking ahead to 2011, do you expect: Basel III regulations will cause consumer lending to Regulations designed to protect consumers will cause consumer lending to New banking regulations will cause profits from retail consumer and SME portfolios to 0% 20% 40% 60% 80% UK an Ireland Looking ahead to 2011, do you expect: Basel III regulations will cause consumer lending to Regulations designed to protect consumers will cause consumer lending to New banking regulations will cause profits from retail consumer and SME portfolios to 0% 20% 40% 60% 80% 16

17 european credit risk outlook Respondents profile More than 100 individuals from 32 countries completed the first European credit risk managers survey. Respondents included representatives from smaller institutions as well as global banks, and the majority (81%) are from full-service banks. Some 40% of the banks represented in the survey are owned by foreign entities. Just 5% of respondents work at online-only banks. What is your area of responsibility? Check all that apply 70% 60% 50% 40% 30% 20% 10% 0% Credit / Mortgages debit cards Auto loans Current accounts Lines of Small credit business loans CIO / IT CFO / Finance Over 90% of respondents held some level of responsibility for a consumer or Small and Medium Enterprise (SME) credit offering. Just over 6% of respondents supported the technology functions of their institution, while approximately 2% represented the finance function. 17

18 How many employees does your bank have? Over 100,000 50,000-10% 100,000 6% 10,000-50,000 28% 5,001-10,000 16% 1-5,000 40% The diversity of size is reflective of the European banking market, and is representative of the Efma membership. How many retail customers does your bank have? Over 5 million 26% 1-50,000 5% 2 million- 5 million 17% 1 million- 2 million 17% 50, ,000 13% 250, ,000 10% 500,001-1,000,000 12% Over 40% of the respondents indicated their organizations served in excess of 2 million customers, while only 18% of respondents banks were serving fewer than 250,000 customers. This is consistent with the high portion of respondents that report affiliation with a multinational or global enterprise. Business orientation of your institution Credit Card Monoline Mortgage 2% lender 2% Retailer or Finance Company 13% Building Society 2% Full-service bank 81% Respondents are overwhelmingly affiliated with full-service banks, giving the sample a high degree of homogeneity in business orientation. This means that while there will be regional differences and differences of opinion borne from product diversity, the type of issues experienced by the respondents as full-service banks operating in Europe should be expected to be fairly consistent. 18

19 european credit risk outlook In which country are you based? Other European 49% United Kindom 13% Benelux 10% Iberian Pennisula 9% Turkey 10% DACH 9% The United Kingdom, Benelux (with The Netherlands itself among the top respondents) and Turkey were among the top responding countries, while The Iberian Peninsula (Portugal and Spain), the DACH countries (Germany, Austria, Switzerland) and Greece / the Balkan region also provided numerous responses. There is a strong connection between the headquartering of a bank in the UK, Spain, Austria or Italy and the likelihood of multi-national or global operating presence. What region does your bank operate in? Global 18% National 38% Multi-Country 44% Again, the multi-national focus of respondents reflects the make-up of the European banking structure. 19

20 FICO (NYSE:FICO) delivers superior predictive analytics that drive better decisions. As a pioneer in applying mathematics to solve business problems, FICO gives businesses the power to make more effective decisions based on sharper forecasts of consumer behaviour. FICO s revolutionary solutions include the FICO Score the world s best-selling credit score, and the standard measure of US consumer credit risk as well as the leading global solutions for credit account management and fraud management. Most of the world s top banks, as well as leading insurers, retailers, healthcare and pharma companies and government agencies, rely on the analytic advantage of FICO solutions to accelerate growth, control risk, reduce costs and meet regulatory and competitive demands. Fair Isaac Corporation 5 th Floor Cottons Centre Hays Lane London SE1 2QP United Kingdom Tel: +44 (0) Efma (European financial marketing association) is the leading association of banks, insurance companies and financial institutions throughout Europe. On a non-for-profit basis, Efma promotes innovation and best practices in retail finance by fostering debate and discussion among peers supported by a robust array of information services and numerous opportunities for direct encounters. Efma was formed in 1971 and gathers today more than 3,000 different brands in financial services worldwide, including 80% of the largest European banking groups. Efma 8, rue Bayen Paris France Phone:

21 2011 Fair Isaac Corporation. All rights reserved. This report should not be reproduced or redistributed, in whole or in part, without the written permission of Fair Isaac Corporation. 21

22 European credit risk outlook February 2011 Best practices in retail financial services more information on and RP 02/11 PDF