Don't fret, consumer finance loans not a threat to Korean banks

And neither are credit card advances.

Moody's Investors Service says that consumer finance loans and credit card advances -- despite the rise in unsecured household credit -- do not pose a material threat to broader financial system stability in Korea, nor to the Korean credit card ABS transactions.

"This conclusion reflects the fact that consumer finance companies exhibit high levels of profitability, providing them with considerable buffer to absorb cyclical rises in credit costs under normal circumstances," says Jeffrey Lee, a Moody's Associate Analyst.

"Also, credit card companies -- the key provider of credit card advances -- have over the years tightened their eligibility criteria," says Lee.

Moody's conclusions were contained in its just-released report, "Korean Banks: Unsecured Consumer Finance and Credit Card Advances Pose Only Limited Risks to Banking System and ABS Investors", co-authored by Lee and Joe Wong, AVP -- Analyst.

Unsecured household credit is a key driver of Korea's rising household credit and -- by Moody's calculations -- totaled KRW354 trillion at end-2014, or 32% of total household credit, or 30% of Korea's disposable income.

Moody's views consumer finance loans and credit card advances as two riskier forms of unsecured household credit. In particular, borrowers from consumer finance companies generally have low income and poor credit scores, which makes this loan segment among the first to suffer from any potential weakening in household finance conditions.

However, as indicated, the consumer finance sector is robust, and its companies, after a decade of substantial consolidation, have demonstrated sustained loan profitability and good underwriting skills, which will allow them to withstand a significant increase in defaults.

Many consumer finance companies have also acquired saving banks to reduce their funding costs, a move which will help them deal with rising regulatory pressure to lower the lending rate ceiling, currently set at 34.9%.

In addition, direct links between the consumer finance sector and the banking sector in Korea are limited, as Korean banks neither own nor fund consumer finance companies, and the two segments are distinct in terms of their customer bases.

Finally, even in the unlikely event of a severe credit deterioration that leads to a widespread failure among consumer finance lenders, Moody's expects a limited impact on Korean banks, because the two financial industry sectors share few direct or indirect links.

Consumer finance companies operate largely outside the formal banking system, both in terms of their business scope as well as their funding and ownership.

Many credit card companies have also used the ABS market to transfer some of the risk from these receivables. Nevertheless, investors in these securities will only suffer loss under extreme stress because of the multiple structural protections existent in these transactions because of the available structural protections.

The protections include limitations on the portion of cash advance receivables, which are riskier compared to consumption-related receivables, in the securitized portfolio. In addition, the transactions
appoint back-up servicers which can take over the servicing of the credit card receivables if the original servicer fails.