What the 2014-16 Oil Price Crash Can Tell Us About Recessions and Loan Performance

December 20, 2019

Even as the U.S. economy continues to put in a strong showing, with key indicators such as payrolls and consumer spending still improving, recession concerns persist.1 Trade war impacts, fears over a potentially disorderly Brexit, and a demonstrable slowdown in the global industrial economy are all factors weighing on investors’ and central bankers’ minds. While consumer sentiment and overall health appear to still be performing, we are carefully tuned to how they could be negatively affected when a recession eventually hits.

We’ve said before, that with consumers in a pretty good position, we think the likelihood a recession will be consumer-led is fairly low. On the other hand, the high level of corporate debt leverage, three times greater than levels reached before the last recession, does concern us.2

With that in mind, we took a look at what the next recession could look like and how loan performance could be affected, through the lens of the 2015/2016 oil price shock and the corresponding increase in Houston’s local unemployment rate as plummeting oil prices triggered a wave of layoffs in energy sector-related jobs. We chose to look at the unemployment rate because we found it be the factor to which consumer credit shows the greatest sensitivity.

Do you read me Houston?

Given the energy sector’s significant contribution to Houston’s economy,3 2014-2016’s oil price crash caused a temporary spike in the local unemployment rate to recessionary levels. We believe looking at the knock-on impacts of what was in essence a localized recession, provides an opportunity to gauge a potential recession’s impact on unsecured personal loan performance.

Additionally, we view Houston as a good benchmark, given its size. It’s the fourth-largest U.S. city, with a metro area population of just under 7 million in 2016. And its contribution to U.S. GDP ranked it as the seventh largest U.S. metropolitan statistical areas (as of 2017).4

During the 2015-2016 oil price crash, crude prices fell by more than two-thirds from their 2014 peak. Challenger, Gray, & Christmas’s “2016 July Job Cut Report” put total industry job losses over that timeframe at 195,415. We observed a 1 ½% increase in Houston’s local unemployment rate starting in the fourth quarter of 2014 and continuing into the third quarter of 2016.

Our findings

To conduct our analysis, we used TransUnion (TU) industry data on how personal loans to Houston borrowers performed during that period. We also measured the sensitivity of consumers in various credit bands to the unemployment rate. While our analysis is hypothetical and presents just one potential view of what could happen in a recession, we believe it provides some helpful data points.

  • When we applied the sensitivities from TU’s study to Moody’s moderate recession scenario, the results suggested cumulative lifetime loan losses could increase by 30-50% for a 4% increase in the unemployment rate.

1-yr Bad Rate by Vintage (TransUnion consumer loans, industry total)

  • We also found that the impacts varied by credit segments. Loans made to borrowers in the highest two credit tiers experienced a greater change in loss rates (+10%) and (+14% for the very highest) than those made to borrowers in lower credit tiers (+8%).5
  • Overall, the data suggests a potential negative impact to returns in the single digits depending on loan grade and term. Of course, the timing of the loan purchase relative to when a recession hits also matters.6
  • These results reinforce our earlier analysis of recessionary impacts on delinquency rates, charge-off rates, and returns on banks’ unsecured personal loans, discussed in “Marketplace Loans: How Might They Perform in a Downturn?

What could the next recession might look like and how might unemployment increase?

We think the next recession could look a lot like 1991. Back then, the unemployment rate peaked near 7% (up from 1990’s 5.4%), then continued to rise for more than a year, eventually reaching 7.7%.7 In contrast to 2007-2009’s Great Recession, when the official unemployment rate peaked at 10%,8 the 1991-92 recession did not have a single precipitating factor. It was multifaceted, with monetary policy, oil price shocks, weak consumers, and a loss of business confidence all contributing factors.

Similarly, the current economic backdrop, with the trade war knocking back business confidence, and event risk present in the form of Brexit uncertainty, already suggests a confluence of potential drivers for a future recession. Additionally, given the current historically low unemployment rate, a 4% increase in a recessionary scenario seems entirely reasonable.

What’s the bottom line?

This analysis, along with the wealth of borrower data we have will enable us to act nimbly and take smart, proactive steps ahead of and during an economic downturn. Additionally, as usual, we continue our routine monitoring activities. Externally, these include periodic meetings with Moody’s to discuss changes in the economic backdrop and in consumer credit. Internally, they include constantly testing borrower behavior, which allows us to make real-time adjustments, including targeted cuts to higher-risk borrower categories, rather than just bluntly tightening, as the credit environment changes.

 

Important DisclosuresNo offer to sell or purchase securities. The article does not constitute an offer to sell, or a solicitation of an offer to buy, any security and may not be relied upon in connection with the purchase or sale of any security. Any such offer would only be made by means of formal offering documents, the terms of which would govern in all respects. You are cautioned against using the article as the basis for a decision to purchase any security or to otherwise engage in a relationship with LendingClub or its affiliates.

No reliance, no update, and use of information. The article does not purport to be complete on any topic addressed. The information in the article is believed to be accurate as of the date indicated, and LendingClub does not intend to update the information after its distribution, even in the event that the information becomes materially inaccurate.

Past performance. In all cases where historical performance is presented, please note that past performance is not necessarily a reliable indicator of future results and should not be unduly relied upon as the basis for making an investment decision.

No tax, legal, accounting, or investment advice. The article is not intended to provide, and should not be relied upon for, tax, legal, accounting, or investment advice.

Forward looking statements. Some of the statements in this article, including statements regarding the timing and cause of a recession and anticipated loan performance during changing economic cycles, are “forward-looking statements.” The words “anticipate,” “believe,” “estimate,” “expect,” “intend,” “may,” “outlook,” “plan,” “predict,” “project,” “will,” “would” and similar expressions may identify forward-looking statements, although not all forward-looking statements contain these identifying words. Factors that could cause actual results to differ materially from those contemplated by these forward-looking statements include those factors set forth in the section titled “Risk Factors” in our most recent Quarterly Report on Form 10-Q and Annual Report on Form 10-K, each as filed with the SEC. We may not actually achieve the plans, intentions or expectations disclosed in forward-looking statements, and you should not place undue reliance on forward-looking statements. Actual results or events could differ materially from the plans, intentions and expectations disclosed in forward-looking statements. We do not assume any obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law.

  1. Bureau of Labor Statistics, “Employment Situation Summary,” https://www.bls.gov/news.release/empsit.nr0.htm, November 1, 2019; U.S. Census Bureau, “Monthly New Residential Construction, September 2019,” https://www.census.gov/construction/nrc/pdf/newresconst.pdf, October 17, 2019; “Personal Income and Outlays, September 2019,” Bureau of Economic Analysis (BEA), https://www.bea.gov/news/2019/personal-income-and-outlays-september-2019, October 31, 2019.
  2. Bloomberg, “Corporate America Binges on Debt After Promising Austerity,” https://www.bloomberg.com/news/articles/2019-09-30/corporate-america-is-bingeing-on-debt-after-promising-austerity, September 30, 2019.
  3. Greater Houston Partnership, “The Economy At A Glance,” https://assets.recenter.tamu.edu/documents/mktresearch/Houston_Economy_at_a_Glance.pdf, January 2018.
  4. Greater Houston Partnership, “Annual Update: Gross Domestic Product,” https://www.houston.org/houston-data/annual-update-gross-domestic-product, 11/7/2018.
  5. Less risky loans experienced a bigger increase in the rate of losses, though not in loss multiples. This increase reflected the disproportionate impact of a small change given the low initial level of loss rates for less risky loans.
  6. LendingClub: “Marketplace Loans: How Might They Perform in a Downturn?
  7. Cornell University ILR School, “The ‘Jobless Recovery’ from the 2001 Recession: A Comparison to Earlier Recoveries and Possible Explanations,” https://digitalcommons.ilr.cornell.edu/cgi/viewcontent.cgi?article=1194&context=key_workplace, 8/12/2004.
  8. BLS Spotlight on Statistics, The Recession of 2007–2009, “The Recession of 2007–2009,” https://www.bls.gov/spotlight/2012/recession/pdf/recession_bls_spotlight.pdf, February 2012.

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