consumer confidence not improve despite record-high...

STRUCTURED FINANCE

SECTOR COMMENT6 AUGUST 2015

ANALYST CONTACTS

Antonio Tena, Ph.D. [email protected]

Greg O'Reilly [email protected]

Paula Couce Iglesias 44-20-7772-1420Associate [email protected]

EMEA ABS

Consumer Loan Performance inIreland, Italy, Portugal and Spain WillNot Improve Despite Record-HighConsumer ConfidenceConsumer confidence in four peripheral euro area economies (Spain, Portugal, Italy andIreland) has reached a record high not seen since 2007. Despite this positive sentiment, theperformance of consumer loan asset-backed securities (ABS) in these countries is unlikely toimprove significantly.

Consumer confidence data has a low correlation with deal performance. Current recordhighs will not lead to significant performance improvement based on several factors.Unemployment remains at peak levels in the periphery, which will continue to hurtconsumers' ability to pay their debts. Any improvement in this regard will first benefitresidential mortgages, not consumer loans, in our view.

Consumer confidence in Spain, Portugal, Ireland and Italy is above pre-crisis levels.Consumer confidence has risen markedly in Spain, Portugal, Ireland and Italy over the last

two years, as Exhibit 1 shows.1 The consumer confidence index in these four countries hasrisen to levels not reached since 2007. Moreover, consumer confidence in these countries hasexceeded the overall consumer confidence level in the euro area.

Exhibit 1

Consumer Confidence in Spain, Portugal, Ireland and Italy Compared With the Euro Area

Source: Moody's Investors Service, INE Spain, INE Portugal, ISTAT Italy and ESRI Ireland

http://www.surveygizmo.com/s3/1133212/Rate-this-research?pubid=1006170

MOODY'S INVESTORS SERVICE STRUCTURED FINANCE

This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page onwww.moodys.com for the most updated credit rating action information and rating history.

2 6 AUGUST 2015 EMEA ABS: CONSUMER LOAN PERFORMANCE IN IRELAND, ITALY, PORTUGAL AND SPAIN WILL NOT IMPROVE DESPITE RECORD-HIGH CONSUMERCONFIDENCE

Historically, we have observed that sudden drops in consumer confidence in these countries translated to a deterioration in consumerloan performance. Certain national events (mainly government announcements of austerity measures) have also affected these

developments.2

Consumer ABS deal performance will not mirror the record-high in consumer confidence. Two main factors prevent consumerconfidence from significantly benefitting loan performance in the euro area periphery:

1) Unemployment remains at peak levels, and will not significantly fall within the next two years (see Exhibit 2).

Exhibit 2

Moody's Investors Service Forecast on Unemployment

Ireland Italy Portugal Spain2015 9.6 12.5 13.8 22.92016 8.7 12.5 13.4 22.02017 8.0 12.3 13.0 21.0

Source: Moody's Investors Service

Stagnant incomes for a significant segment of households will continue to hurt consumers' ability to pay off debt. The Spanish marketis especially sensitive to unemployment.

2) If consumers' ability to pay debt improves, they would be likely prioritise paying their residential mortgages, not their consumerloans, owing to the full recourse nature of the former. On the contrary, consumer loans are unsecured, with creditors facing borrowers'willingness to pay.

SPAINConsumer confidence in Spain is at its highest point in over a decade. Consumer confidence reached 105.6 in July 2015, itshighest point since 2004. The index in Spain exhibits the best correlation with consumer loan performance out of the other peripheralcountries examined in this report. Consumer confidence correctly predicted delinquency performance 12 months later in 75% ofquarterly data points (see Exhibit 3). However, at present, arrears are high, in parallel with consumer confidence.

Exhibit 3

Consumer Confidence versus NPL Consumers Loans Index in Spain

Source: Bank of Spain, Centro de Investigaciones Sociológicas (CIS)



Negative consumer sentiment had a relatively strong correlation with loan performance in periods of decline. The highestmonthly drop in consumer confidence occurred in the summer of 2012, matching the following announcements: 1) the beginning ofdiscussions to restructure the Spanish banking system; 2) a VAT increase; 3) the end of extra Christmas pay for civil servants, amongothers. One year later, the non-performing loan (NPL) index sharply deteriorated.

Conversely, improved loan performance has not accompanied a rise in consumer confidence in several instances. At theend of 2008, consumer confidence was up sharply but performance did not improve. Consumers' optimism stemmed from generalelections and optimistic news (“green shots”) which, on the contrary, did not manifest in an improvement in the economy. We observethe same divergence, as consumer confidence has steadily risen since Q3 2012, while arrears remain high. Unemployment remainswidespread in Spain, at above 20%.

Consumer confidence has proven to be a better predictor of consumption levels than loan performance. Spain's economygrew by 2.7% year-on-year in Q1 2015, while National Accounts shows that household final consumption expenditure is growing even

faster, at 3.5%.3 However, an alternative measure of consumption reported by the Household Budget Survey seems to be more in linewith the weak performance of Spanish consumers in Spain. According to this measure, the average household expenditure in 2014 was

€27,038 (in current terms) which is 0.2% lower than 2013 and 15.0% lower than pre-crisis levels.4

ITALYConsumer confidence in Italy has reverted to pre-crisis levels, reaching 106.5 in June 2015. We assessed the relationshipbetween consumer confidence and loan performance using the Moody’s Italian consumer loan ABS index. In the past, consumerconfidence correctly predicted delinquency performance 12 months later in 69% of quarterly data points.

Exhibit 4

Consumers Confidence versus Moody’s Italian Consumer Loan ABS Index

Source: ISTAT, Moody's Investors Service

Italian consumer confidence does not always indicate future ABS performance. Although consumer confidence and ABSperformance have previously been correlated, we do not think this reflects a strong causal relationship. This is because, in addition tomacroeconomic health, key national events (such as elections or announcements of new policies) also affect confidence levels.

For instance, consumer confidence rose to 102.8 in June 2014 from 94.6 in February 2014, likely in response to the Italian generalelections and the government's announcement of tax cuts and economic reforms. However, over the twelve months to February 2015,Italian 90-180 day arrears fell 0.5% to 1.17%, a much greater improvement than that implied by consumer confidence. We also thinkthe drop in sentiment to 97.7 in December 2014 from 102.6 in May 2014 is more likely a consequence of the impact of bad weather onthe agriculture and tourism sectors than indicative of changes in consumer health.



Italian ABS performance will not necessarily improve following a rise in consumer confidence. The data in Moody’s Italianconsumer loan ABS index exhibit a much stronger performance, compared with Italy’s national consumer NPL index. According toItaly's national index, NPLs have more than doubled to 7% in 2014 from 3% during the crisis. This is partly owing to changes in thecomposition of Moody's index. For example, since Q4 2012, more than 45% of the index has included deals with underlying Cessione

del Quinto5 loans, which have lower credit risk than standard consumer loans.

IRELANDConsumer confidence has bounced back from its trough in 2008. Confidence reached 99.7 in July 2015, which is comparable toIreland's pre-crisis levels. However, such increases are not reliable indicators of future loan repayment performance. A lack of consumerloan default data prevents a direct comparison of consumer confidence indices with the evolution of defaults in consumer loans across

the country.6 We assessed the relationship between consumer confidence and consumer health by using data on Irish mortgagepayments as a proxy for likely ABS performance. This is because we believe mortgage payment trends are relevant indicators for IrishABS assets, since the borrowers in Irish ABS and residential mortgage-backed securities' (RMBS) pools tend to overlap.

There is no meaningful relationship between consumer confidence and Irish RMBS performance. Delinquencies of 90+ daysin our RMBS index stabilised at a low level through 2006-2008 while consumer confidence was falling. Furthermore, arrears continuedto rise until 2014, even though Irish consumer confidence was generally improving from the second half of 2010. As a result, consumerconfidence only correctly predicted delinquency performance 12 months later in 53% of quarterly data points.

Exhibit 5

Consumers Confidence versus Moody's RMBS 90+ Delinquencies Index in Ireland

Source: ESRI, Moody's Investors Service

Political developments that do not reflect economic changes have influenced Irish consumer confidence. For example, thefall in consumer confidence in Q3 2010 related to the €85 billion rescue package with the European Union (EU) and IMF, entailing fouryears of tax rises and spending cuts. Consumer confidence improved in 2012, when fears had eased due to expected lower interest

rates and slight improvements in the economic outlook.7 Rising confidence in 2013 and 2014 has been attributed to a “relief rally”

following some difficult years, supported by Ireland's exit from the EU/IMF assistance programme.8 While it would appear thatconsumer confidence reflected economic factors (such as GDP growth and unemployment, which began to improve between 2009and 2011), these factors did not lead to a reduction in 90+ arrears in Moody’s RMBS index (see Exhibit 6). We believe this reflects thelevel of indebtedness in Ireland, which has driven higher RMBS arrears and dominated other positive economic factors.



Exhibit 6

Consumers Confidence versus GDP Growth and Unemployment in Ireland

Source: ESRI, Moody's Investors Service

PORTUGALWeak correlation of consumer confidence and loan performance. Consumer confidence reached 81.0 in July 2015,9 its highestpoint in 13 years (since 2002). Consumer confidence correctly predicted delinquency performance 12 months later in 60% of quarterlydata points (see Exhibit 7).

Exhibit 7

Consumers Confidence vs Consumers Loan NPL Performance in Portugal

Source: Bank of Portugal, INE Portugal

Portuguese consumer loan performance has severely deteriorated. The NPL index of Portuguese consumer loans has continuedto rise since 2009, having doubled to 15% from 7%. Conversely, consumer confidence had already begun to shift in 2012. Improvedsentiment did not result in better loan performance, which deteriorated in 2015. The pattern of consumer confidence in Portugal hasbeen very similar to that of Italy, as a prolonged rise in confidence has not preceded a subsequent improvement in the national NPLindex for consumer loans.

Occasionally, consumer confidence has still provided some guidance when it has declined. There is still some consistencyin the data for Portugal, considering that there is a gap of 20 points between consumer confidence in Portugal compared to Spain,Italy and Ireland. Portugal has the highest level of consumer NPLs (15% compared with 7%-11% for the other three countries). Like



Spain, the highest monthly drop in consumer confidence followed the announcement of the government's main austerity package inSeptember 2010.

Consumer Confidence is a Weak Indicator of Future Deal Performance

Consumer confidence is used for economic prediction, particularly for households’ future economic actions. This is because itsynthesises economic developments and trends (which can be used as an “explanatory component” or “signal”) that are relevantfor ABS performance prior to the economic data becoming available. However, it also reflects non-economic events (which can beconsidered as “noise”) that do not predict ABS performance. Most fluctuations in consumer confidence reflect movements in othermacroeconomic variables, such as unemployment, interest rates (with which consumer confidence has a negative correlation), wagesor GDP (with which it has a positive correlation).

Movements in consumer confidence indices do not always follow the same trends as the determinants that drive ABS performance.This suggests that there is “noise” in the consumer confidence measure that may reflect the impact of key events (such as wars andelections) on households’ expectations. Consequently, when consumer confidence is dominated by “noise”, it does not explain futureloan performance, because it does not reflect the economic developments that shape consumers’ ability to repay their debts. Evenwhen consumer confidence reflects economic trends, these factors may have less impact on consumer health if other economic driversprove more important to consumers' ability to repay their debts.

Therefore, it is important to understand the drivers behind shifts in consumer confidence before determining its predictive power forconsumer loan performance - and subsequently on consumer loan ABS securitisations.

How Consumer Confidence Indices Are Calculated by Public Bodies

Each index is the result of a national survey to individuals performed by a public body, including questions which are very similar acrosscountries (generally, over a period of 12 months in the case of Portugal, Italy and Ireland, six for Spain):

- How do you expect the financial position of your household to change over the next months?

- How do you expect the general economic situation in this country to develop over the next months?

- How do you expect the number of people unemployed in this country to change over the next months?

- Over the next 12 months, how likely is it that you will save any money? (only in Portugal); and

- What do you think about people buying large items such as furniture, washing machines, TV sets etc.? Do you think that, for peoplein general, the present conditions are (good/neither good nor bad/bad)? (only in Ireland)

At the same time, other questions gather information related to how the current situation of the national and household economycompared to the past (six or 12 months' time).

Finally, the public body calculates the index as the arithmetic average of the balances of the former questions. Typically, the index iscalculated using “100” as a basis. This means that 100 represents the point of balance, if there are the same number of positive andnegative answers to the questions. For instance, if in a population of 100, the survey shows 20 positive answers, 25 negative answersand 55 neutral answers, the index will show a score of 95 (20-25+100).



Endnotes1 For more details on how consumer confidence indices are calculated, please see “How Consumer Confidence Indices are Calculated by Public Bodies”

Section at the end of the report.

2 For more details on how different factors are affecting the consumer confidence indices, please see “Consumer Confidence is a Weak Indicator of FutureDeal Performance” Section at the end of the report.

3 Growth In Spanish Household Spending is Credit Positive for ABS SME Performance , March 2015

4 Household Budget Survey (HBS) by INE provides annual information on the nature and destination of consumption expenses, as well as on a rangeof features relating to household living conditions. Consumption expenses refer both to the monetary flow into the home for paying for specific finalconsumption goods and services, and to the value of goods received for self-consumption, self-supply, payment in kind, free or subsidised food and rentof the dwelling in which the household lives (when it is owned or granted by other households or institutions). Expenses are recorded at the time ofacquisition, irrespective of whether payment is in cash or in instalments.

5 Under a Cessione del Quinto (CDQ) loan, the debtor assigns to the lender up to one fifth of his net monthly salary or pension to cover his loan obligations;loans are collateralised by the monthly salary of the employee/pension (net of taxes), plus any eventual severance pay treatment (TFR). In addition, anobligatory insurance policy protects against loss of job, resignation and death of the debtor. These characteristics provide CDQ a stronger creditprofilewhen compared to standard consumer loans. This explains the difference of performance shown by the national consumer loan NPL index compared toour Consumer Loan 90-180 Days Delinquency Index, on top of the exclusion of loans more than 180 days delinquent.

6 We were unable to find nationwide data for the performance of consumer loans in Ireland as the underlying loan by loan data that the Bank of Irelandreceives is not made publicly available.

7 Source: KBC Blog

8 Source: KBC Blog

9 Portuguese Consumer Index is not actually reported using 100 as balance point (unlike the other three countries in this report), but zero. Hence, the latestobservation stands at -19.0, equivalent to +81.0 to make it comparable to the other countries indices. We have translated all Portuguese indices to thiscomparable scale.

https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBS_1003627

https://www.kbc.ie/Blog/Consumer-Sentiment-Surveys/Irish-Consumer-Sentiment-Surprisingly-Strong-in-Ju

https://www.kbc.ie/Blog/Consumer-Sentiment-Surveys/Irish-Consumer-Sentiment-Surprisingly-Strong-in-Ju



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