S&P Global Ratings expects stability in its ratings on most U.S. finance companies in 2025. But the performance of those companies will depend meaningfully on economic growth, interest rates, market volatility, and regulation--all of which the new presidential administration likely will affect.

About 80% of our ratings on finance companies have a stable outlook. Ratings on 13% have a negative outlook or are on CreditWatch with negative implications--mostly in commercial real estate (CRE) lending and services. And about 7% have a positive outlook or are on CreditWatch positive; these are across multiple sectors, in part for idiosyncratic reasons.

In their base case, S&P Global Ratings economists expect the U.S. economy to grow 2% in 2025, with some reduction in interest rates. That said, they see a high level of uncertainty given unknowns about how many of President Donald Trump's campaign promises will materialize. The rate of economic growth, the level of short- and long-term rates, global trade activity, asset prices, and market conditions will have important implications for rated finance companies.

Macroeconomic factors will affect the activity of transportation equipment lessors and money transfer companies, the originations and asset quality of lenders and servicers, and the funding conditions of nonbank financial institutions (NBFIs) in general. For instance, we expect asset quality--which has weakened in the past two years--to deteriorate somewhat further, especially in the subprime space, especially if the economy slows more than expected. Delinquencies and charge-offs will likely keep rising for auto lenders (exacerbated by a drop in used car prices) as well as for other consumer lenders.

Commercial lenders, including business development companies (BDCs), may also see a further rise in problem loans and payment-in-kind (PIK) income depending on the rate environment. That said, we expected any asset quality worsening to be manageable for BDCs and other commercial lenders, helped in part by low leverage and other strengths.

CRE lenders--a sector where half of our ratings have a negative outlook--will also likely see additional asset quality pressures on loans backed by office properties as well as some other transitional properties. Interest rates will play a role for CRE lenders as well. A meaningful drop in rates could help ease property price declines and alleviate some debt service pressure on borrowers, while stubborn rates could exacerbate pressures.

Lower rates could also boost the businesses of CRE services companies. While some of our ratings on those companies remain on negative outlook, their leasing and capital markets activities have improved. Likewise, rates will be a key factor for residential mortgage and servicing companies. After dipping, 30-year mortgage rates have climbed back to around 7%, weighing on origination. Still, we expect some decline in rates to boost activity from the low level over the past two years.

Changes in rates and credit spreads will be a key determinant of funding for NBFIs. Investment-grade companies have maintained strong access to the debt markets, and a tightening in credit spreads has aided many speculative-grade NBFIs' access to the market as well.

Lastly, 2025 could see meaningful changes in the approach to regulation at the federal level. The Trump administration's potential appointment of a new director for the Consumer Financial Protection Bureau could ease some regulatory risk for companies.

The Trump administration, through regulatory appointments, will also affect the tone and substance of bank regulation, which could have indirect impacts for NBFIs. Tighter bank regulation since the global financial crisis has created opportunities for NBFIs, perhaps helping to facilitate the growth of private credit and nonbank lending in general. While bank regulation could ease somewhat in 2025, we still would expect nonbank credit intermediation to grow.

BDCs And Leveraged Lending See Robust Originations And Strains On Asset Quality

Key credit drivers

State of the economy.  Market trends and valuation marks remained favorable in 2024, and we anticipate this will continue in 2025 based on expected EBITDA growth for upper-middle market companies and potentially increased mergers and acquisitions (M&A) activity. Having said that, an expected economic slowdown, sustained inflationary pressures, the potential impact of trade wars, and higher-for-longer interest rates mean that BDCs and commercial lenders--which typically focus on lending to highly leveraged middle market companies--could see borrowers in certain sectors have difficulty passing higher costs to end users and come under stress.

Potential decline in base rates.  Lower interest rates could boost origination volumes by increasing M&A activity. We expect origination volumes in 2025 will primarily be the result of increased M&A. We could continue to see refinancing activity depending on the direction of credit spreads as loans exit their noncall periods. However, lower interest rates will also lead to lower yields on investments in 2025, thus partially offsetting the expected rise in deal volume.

Fierce competition in middle market lending.  We expect private credit will continue to provide refinancing options to issuers traditionally in the broadly syndicated loan (BSL) markets. We expect upper-middle market lending to remain competitive as the BSL market continues to regain lost ground and asset managers either launch their own BDCs or acquire an established lender. The increase in funding options for borrowers has mirrored the spread compression in the BSL markets and private credit market to a low of about SOFR + 450 for upper-middle market direct lenders. We do not expect credit spreads to widen significantly given rising competition.

We believe that direct lenders' ability to write larger checks will allow them to effectively compete with the BSL market. Flush with cash and significant fundraising due to continued demand, especially in the high-net-worth channel, there will likely be an urgency to deploy capital in 2025 (especially for the nontraded BDCs) that could influence underwriting standards, and in turn hurt asset quality.

Access to diversified funding markets.  In 2024, the decline in base rates, coupled with increased investor risk appetite, led to credit spread tightening that allowed most companies unfettered access to secured and unsecured markets. Furthermore, BDCs issued more collateralized loan obligations (CLOs) as an alternative source of funding, given the tightening liability spreads for this asset class and the funding term that is matched to the asset's maturity. These allowed the companies to diversify their funding options and use the proceeds to fund portfolio growth, reduce funding cost, and address upcoming corporate debt maturities. Amid increased investor appetite and tight credit spreads, a few BDCs have already tapped the unsecured debt market in 2025.

What to look for over the next year

Strain in asset quality.  We remain focused on a potential weakening in asset quality through increased nonaccruals, PIK income, and realized and unrealized losses. S&P Global Ratings forecasts that the U.S. trailing-12-month speculative-grade corporate default rate will decrease to 3.75% by mid-2025, down from a peak of 4.9% in April 2024. Consistent with this forecast, we expect that realized and unrealized credit losses will likely improve for most BDCs and other commercial finance companies as base rates remain steady and the underlying health of upper-middle market borrowers remains resilient.

PIK income increased in 2024. Most PIK income continues to be associated with performing investments that were originated with a PIK feature, with only a small percentage of investments amending cash interest to PIK. We view amended PIK investments as an indicator of stressed borrowers. In 2025, we expect overall PIK income will rise--it's predominantly fixed rate, and reduced base rates will lead to lower net investment income (denominator effect), unless this is offset by growth in non-PIK investments.

While newer BDCs have no loans on nonaccrual in their short operating history, we expect nonaccruals to rise as portfolios go through a credit cycle. Still, we expect them to remain in line with nonaccruals for the broader BDC industry. Recent Federal Reserve rate cuts may not be deep enough for borrowers struggling to maintain cash flow and meet interest payments. We expect higher-for-longer interest rates will test borrowers in certain sectors that may struggle to pass rising costs to end users, constraining those borrowers' ability to service debt and increasing the probability of default.

Earnings pressure.  While pent-up demand and expected lighter regulation will boost M&A activity in 2025, we expect that rising competition, coupled with tighter spreads for upper-middle market loans, could lead overall earnings to decline as more investments are underwritten at current spreads. The average EBITDA of the BDCs' underlying borrowers has increased in recent periods, and these borrowers have a greater ability to cope with a potential economic slowdown than their smaller peers (see chart 3). While lower base rates will help improve the portfolio's interest coverage ratio for lenders (improving asset quality), it will likely reduce their net earnings. Vintage and single-name-concentration risk persist as BDCs and commercial lenders aggressively deploy larger sums of money.

Sufficient liquidity and manageable refinance risk.  We expect most rated issuers to maintain adequate liquidity through unrestricted cash on the balance sheet and their ability to draw on secured facilities to meet unfunded commitments and upcoming debt maturities. We expect nontraded BDCs with redemption risk to maintain a material investment in liquid loans (Level 2 assets). We also expect refinancing risk to be low for BDCs and commercial lenders, and we expect these companies to prudently address this risk by either accessing the secured or unsecured markets.

Stable valuations and leverage.  The underlying investments for BDCs and commercial credit lenders are illiquid, and we believe that investments marked 80% or lower of cost have a higher likelihood of defaulting. For rated issuers, an average of 5% of investments were marked 80% or lower as of Sept. 30, 2024, unchanged from a year ago. Macroeconomic uncertainty could lead to markdowns on valuations (unrealized losses), which can erode the cushions to BDCs' regulatory asset coverage requirements. In our base case, we expect most rated issuers to continue to operate within their targeted leverage ranges and maintain adequate cushions to their regulatory asset coverage requirements, consistent with expectations for the current ratings.

Older Vintage Loans To Cause Asset Quality Deterioration For CRE Finance Companies

Key credit drivers

The strength of the economy and the direction of interest rates.  Secular changes in the office market have created a major challenge for CRE finance companies. In addition, the performance of the economy, inflation, and interest rates will have important implications given the cyclical nature of CRE and the impact that rates have on CRE prices and funding conditions. The Fed's rate cuts last fall and potential further easing could provide support to CRE values, perhaps making it somewhat less difficult to handle impending maturities on troubled loans. Lower rates may also improve funding conditions for CRE lenders. That said, the Fed may ease policy less than previously anticipated, and long-term rates have climbed in recent months.

Liquidity preservation in the face of asset quality strains.  In 2024, CRE lenders scaled back originations, and that--combined with a precipitous decline in distributable earnings--caused some companies to cut or suspend dividends to preserve liquidity in a challenging CRE market. Throughout 2024, we saw lenders' loan books decline as repayments exceeded new originations and lenders used some of the excess liquidity to make voluntary repayments on these repurchase facilities. In 2025, we expect CRE lenders will remain selective with new originations and will continue to preserve liquidity as they cope with troubled loans and expend capital on real estate owned (REO) properties. Strains in CRE lender books could also lead to margin calls on loans financed through repurchase facilities.

What to look for over the next year

Asset quality challenges.  We expect still-high capitalization rates, pressured property valuations, and loan maturities to continue driving asset quality deterioration across CRE lenders' books in 2025. The level of deterioration will also depend on location, property type, and the underlying quality of the properties securing the loans. Elevated rates have led to high debt service costs on the floating-rate loans that make up most of the portfolios of rated CRE lenders. The level of rates, as well as lower property values, will also likely make it difficult for borrowers to meet 2025 maturities on some properties, potentially leading to additional loan risk migration, increases in credit loss reserves, modifications or growing REO.

Some higher-rated CRE lenders have weathered the higher-interest-rate environment more effectively than others. Those with meaningful exposures to transitional loans tied to office properties or other distressed properties remain pressured headed into the new year. Stubbornly high vacancies combined with hybrid working models force owners to spend capital on improvements to attract tenants and contend with higher implied cap rates that have led to lower property valuations. According to the Mortgage Bankers Assn. (MBA), 7.8% of office loan balances were 30 days or more delinquent as of third-quarter 2024, well above the 5.1% in third-quarter 2023. Some lenders have also seen challenges on loans on multifamily buildings and other property types. A rise in troubled multifamily loans could exacerbate asset quality pressure as CRE lenders have increased their exposure to multifamily since 2020 to offset office exposure. Office and multifamily exposures accounted for a combined 50%-60% of total CRE lender portfolios as of Sept. 30, 2024 (see charts 5-6).

Resolution on troubled assets.  In 2024, CRE finance companies migrated a meaningful portion of their loans to their lowest '4' and '5' risk-based categories on their internal rating scales, which led to an increase in loss reserves and a decline in distributable earnings. These loans make up a significant percentage of several rated CRE lenders' adjusted total equity, and any further deterioration in these assets could directly hurt leverage because specific reserves are booked against those troubled loans. To counter this, lenders reduced or suspended dividends to shore up liquidity and earnings retention. We expect that to be somewhat offset by climbing liquidity needs as asset credit quality remains pressured and the REO portfolio builds.

We also expect CRE finance companies, which typically have expertise in dealing with troubled properties, to resolve loans by extending maturities, seeking partial loan paydowns, or taking over the underlying property through or in lieu of foreclosure. As a result, over the past year, REO as a percentage of CRE lenders' books increased as they absorbed losses through previously booked specific reserves or additional provisions. We expect that trend to continue in 2025 as loans come due. As of Sept. 30, 2024, five CRE lenders (out of the six that we publicly rate) have around $7 billion of loans maturing in 2025; that amount ramps up to almost $15 billion in 2026 (see chart 7).

Funding conditions.  The companies we rate typically depend materially on secured financing, including in the form of repurchase facilities that often have margin call risk and financial covenants. For instance, higher base rates have reduced the cushion on interest coverage requirements, and some companies successfully asked their lenders to amend covenant thresholds. In our view, margin call risk remains meaningful. While some facilities allow for collateral to be marked based on market interest rates and credit spreads, many others only allow for marks if loans securing the facilities have credit events. High rates have also limited most of these companies' access to debt issuance, particularly in the unsecured market. That said, some of the stronger companies in the space were able to issue unsecured and secured debt as well as equity in 2024. In 2025, this sector has manageable corporate debt maturities at $822 million before ramping up to $3 billion in 2027.

CRE Services Are Positioned For Recovery

Key credit drivers

Early signs of recovery in capital markets and leasing businesses.  Interest rate stability and higher liquidity have led to more investment sales and debt advisory activities in recent quarters. There is also stronger demand for office leasing as companies are increasingly committed to more space and longer lease terms. In our base case, we expect the earnings of CRE servicers to improve over the next two years, leading to lower leverage and improved ratings cushion. That said, the magnitude and pace of the recovery will depend on macroeconomic factors such as interest rate stability and business confidence.

Continued growth for resilient revenue businesses.  We expect CRE services companies to achieve steady growth in property and facility management businesses, supported by new client wins and mandate expansion from cross-selling opportunities. While these lines of businesses have a lower margin relative to transactional businesses, they generate recurring revenue streams and provide higher earnings visibility due to longer contract terms.

Additionally, we consider asset management and commercial mortgage servicing as more resilient lines of businesses. While asset management incentive fees are volatile, management fee revenues are relatively stable.

Balanced capital deployment.  We expect CRE services companies to prioritize organic growth and remain opportunistic in shareholder-friendly initiatives such as share buybacks. For companies with excess capital, there could be further talent investments in transactional revenue businesses or M&A activities to broaden their existing service offerings in sectors with high growth, such as data center.

What to look for over the next year

Transactional revenue growth leading to margin expansion.  In our base case, we expect steady improvement of capital markets activities owing to stabilized interest rates and pent-up demand. The recent office leasing recovery continues to reflect the tendency of "flight to quality," which could benefit the top CRE services companies that are more focused on Class A properties. The high operating leverage of transactional revenue businesses will likely lead to meaningful margin expansion across the sector.

CRE recovery accelerating deleveraging.  We believe that the CRE servicing sector has reached the market bottom and that rated companies operated at the higher point of their leverage range through the cycle. While seasonal factors will continue to affect leverage quarter over quarter, the increase of transactional revenue will likely contribute to lower leverage and increased ratings stability. Of the companies we rate, JLL and Newmark have a business model that is more tilted to transactional revenue, which could help accelerate deleveraging if capital markets and leasing businesses have a stronger-than-expected rebound.

Debt capital markets remained open to higher-rated companies in the sector with either unsecured issuance to refinance debt maturities or commercial paper issuances, with backstop revolving credit facilities, to lower funding costs.

Potential rebound in multifamily origination.  Origination volumes stayed subdued across the multifamily CRE market in the first half of 2024. However, there was a meaningful uptick in the third quarter, and we believe that lower interest rates and robust rent growth could lead to higher origination-related revenue for both Greystone Select and Walker & Dunlop in 2025. The MBA forecasts multifamily origination volume rising to $297 billion in 2024 and $390 billion in 2025, up from $264 billion in 2023.

Revenue Visibility And Access To Capital Will Help Transportation Equipment Leasing Remain Stable

Key credit drivers

Favorable supply and demand dynamics for aircraft leasing.  Lessors account for about 50% of the global aircraft fleet and will remain a key component of aircraft financing for airlines. We expect the leasing industry to continue to benefit from constrained supply conditions in 2025 amid persistent new aircraft delivery delays. Engine reliability issues and maintenance, repair, and overhaul (MRO) constraints have also exacerbated the current market imbalance. On the other hand, global air travel demand remains favorable amid a relatively upbeat global macroeconomic outlook, with a bias toward experiences like travel over goods. We believe these factors will continue to support strong lease rates and aircraft values over the next year.

The rate of extensions of expiring aircraft leases is now averaging above 80% across the companies we rate (compared with 50%-60% pre-pandemic). This is positive for profitability because it eliminates associated re-leasing expenses. However, delivery delays have also resulted in a slower capital expenditure ramp-up than previously expected, which limits the ability of the lessors to grow their fleet, maintain a young average fleet age, and further improve scale (particularly for the smaller ones). Nevertheless, the four- to eight-year average age of rated lessors' fleets remains notably younger than the global aircraft fleet age, which has increased to 14.8 years as of December 2024 from just over 13 years in 2018, according to the International Air Travel Assn. (IATA).

Steady performance by freight-focused lessors despite market volatility.  Market conditions for container lessors in 2024 were stronger than in 2023, with demand supported by the ongoing disruptions in the Red Sea, as well as stronger-than-anticipated global trade volumes. On the other hand, operating conditions for U.S. truck lessors have been less favorable over the last two years amid a prolonged weak freight environment due to the post-pandemic inventory destocking, high inflation resulting in uncertainty around consumer demand, and excess trucking capacity. Chassis lessors also experienced significantly lower fleet utilization and pricing compared with the highs of 2021-2022 amid improving supply chain efficiencies (which resulted in lower port dwell, partly offset by somewhat higher import volumes) and weaker domestic freight conditions.

We expect performance in 2025 to be supported by a resilient U.S. economy, offset by a still-sluggish freight environment and an uncertain tariff outlook. However, most freight-focused lessors have the flexibility to reduce capital spending to meet weaker demand as necessary. Many of them also benefit from the medium- to long-term nature of their customer contracts, which provides revenue and earnings visibility.

Ongoing normalization of operating environment for other lessors.  Operating conditions for car renters and fleet management companies were favorable in recent years, but over the past 12-18 months, that environment has moderated for car renters. Higher depreciation expenses and lower gain on asset sales (and in some cases, losses) due to declining residual values as used car prices eased led to weaker earnings on a year-on-year basis. Rental rates were also somewhat lower amid normalizing U.S. air travel demand and higher industrywide fleet supply. We expect similar conditions through 2025 amid steady demand, but we believe fleet and liquidity management remains key in a more normalized vehicle pricing environment (for both new and used vehicles).

We expect that the performance of portable storage and modular space lessors will vary based on the scale and diversification of product offerings, as well as end-market exposure. We expect persistent earnings weakness from smaller lessors focused on a single market (such as residential real estate), while larger lessors with diversified product offerings and exposure to varied end markets will likely maintain steady financial performance through 2025.

Access to capital and liquidity.  The overall financing environment and cost of capital are important for transportation equipment lessors given the capital-intensive nature and spread-focused business model. While the trajectory toward lower interest rates has been slower than prior expectations, credit spreads for most of the lessors tightened noticeably through 2024, which resulted in an uptick in unsecured debt issuances from 2023 levels. Many of the lessors, particularly investment-grade, have also been successful at accessing other forms of financing, including secured debt, preferred stock issuance, and sukuk financing. Speculative-grade lessors, including car rental companies, were also successful in raising new corporate and asset-backed debt to improve their liquidity cushion, meet capital spending needs, or refinance maturing debt. Nevertheless, interest costs are now notably higher than in prior years, especially for lessors who have had sizable capital spending outflows in the past few years.

What to look for over the next year

Interest rates.  S&P Global Ratings expects the Fed to reduce rates more gradually than prior expectations, with rates reaching a neutral rate of 3.1% only by fourth-quarter 2026. We believe most transportation equipment lessors can absorb the impact of these higher costs, particularly the investment-grade issuers. But a further unexpected or sustained increase could lead to interest and cash flow coverage ratios below our downside rating thresholds. The risk is more acute for lower-rated issuers with floating-rate exposure or looming debt maturities.

Relatively stable credit metrics.  For aircraft lessors, we expect revenue to increase, led by new leases signed that reflect current demand and higher interest costs. But elevated interest expenses will limit growth in earnings and cash flow. Additionally, the companies' ability to reprice leases is constrained by the long-term nature of the leases (average remaining lease term of four to eight years). For other lessors, the effects of subdued demand and improved supply (notably for car renters and truck lessors) are likely to temper pricing and volume growth, as well as returns on asset sales. Nevertheless, we expect this to be offset by lower capital spending and interest expenses in most cases, resulting in relatively stable earnings.

We expect leverage levels (debt to capital) to remain steady across most lessors, supported by conservative financial policies across the space, particularly among the larger lessors. Any ratings upside will likely be driven by larger scale, financial policy, or improved earnings or asset characteristics. Downward rating actions are likely to be driven by weaker earnings performance, declining liquidity cushion, or a more aggressive financial policy.

Geopolitical developments, including tariffs.  President Trump announced plans to impose tariff increases on all imports from Canada and Mexico and an additional increase in tariffs on goods from China and the EU. Such measures, if implemented, would likely suppress trade volumes on key routes, which could hurt some of the freight-focused lessors, such as the container lessors. Geopolitical tensions could also deter air travel demand and affect fuel prices, which in turn could affect the performance of aircraft lessors' airline customers.

Used vehicle prices.  Credit metrics for lessors with exposure to cyclical used asset markets--such as car renters and, to a smaller extent, truck lessors--declined in 2024 due to lower gains on asset sales amid a normalization in used vehicle prices after very strong levels through mid-2023. We expect similar trends in 2025 as used vehicle prices gradually decline (albeit at a slower pace than the prior year), supported by a tight supply of two- to four-year-old vehicles following constrained new vehicle production in the post-pandemic period.

Macroeconomic drivers, including consumer spending and travel demand.  We expect a relatively steady macro demand environment and solid consumer spending, particularly in the U.S. However, unexpected macroeconomic weakness in 2025 could strain demand, asset utilization, pricing, and cash flow. While most issuers can respond to this scenario, there would be less capacity to mitigate the impact of weaker-than-expected demand on earnings and liquidity.

Residential Mortgage Originations May Improve If Mortgage Rates Decline And Inventory Increases

Key credit drivers

Elevated mortgage rates.  Mortgage origination volume increased at a slower pace for rated nonbank residential mortgage companies in 2024 year over year because of elevated mortgage rates despite the Fed rate cuts in the second half of the year (see chart 14). We expect originations to improve in 2025 compared with 2024. High mortgage rates, buoyant home prices, lower inventory levels, and reduced purchasing power have compounded the difficulties for residential mortgage companies. We expect originations to remain sensitive to market competition and the mortgage product mix, resulting in potential further volatility. The MBA expects the industry's 2025 origination volume to increase by about 21% year over year, to $2.1 trillion, after increasing by approximately 9% in 2024, to $1.8 trillion.

Mortgage rates remained elevated in 2024 at slightly below 7%, and S&P Global Ratings forecasts a modest decline in 30-year mortgage rates in 2025. Still, we believe the low inventory of homes for sale and affordability challenges will limit origination volume.

Large MSR portfolios.  The value of MSRs, which rated lenders have accumulated on their balance sheets, has moved in the same direction as interest rates. Although mortgage rates recently declined, a large portion of mortgages have rates that are significantly lower than the prevailing rate, which limits the likelihood of refinancing. At the same time, we expect residential mortgage companies to record a slight uptick in recapture rates in 2025 as borrowers look to refinance higher-rate mortgages at lower rates.

As rates remain elevated, the speed of mortgage prepayments remains low, which extends the duration of the underlying cash flows and supports MSR valuations. In addition, MSRs have bolstered the liquidity positions of rated mortgage companies since they may be used as collateral or sold on the secondary market.

What to look for over the next year

Improvement in profitability.  We expect an improvement in profitability in 2025 as residential mortgage origination volume picks up. However, low inventory and high home prices will continue to pressure purchase volume. Although we expect the 30-year mortgage rate to decline as monetary policy eases further in 2025, it is unlikely to spur a surge in refinancing volume because many existing borrowers have already taken advantage of lower rates. Lastly, while some mortgage companies will pursue growth opportunistically as the industry consolidates, we expect most companies to keep focusing on expense management in 2025.

Elevated leverage.  Because mortgage companies expect a conducive environment for mortgage originations, they have invested in technology and added new staff. As a result, we expect that leverage, as measured by debt to EBITDA, will likely remain elevated in 2025. Positively, many of the residential mortgage companies we rate have low ratios of debt to tangible equity and relatively strong balance sheets, which should help them navigate a difficult macroeconomic environment and EBITDA volatility.

Continued growth of MSR portfolios at companies with strong servicing platforms.  As some mortgage companies curtailed or exited certain lending channels, we expect them to continue seeking MSR purchases, subservicing agreements, and special servicing opportunities. As interest rates remain high, we expect mortgage servicing assets to hold their value because of low prepayment speeds and refinancing activity. Companies that have deployed tighter MSR hedging programs have protected themselves from the potential decline in MSR valuations.

Low delinquencies, so far.  We expect mortgage companies' exposure to credit risk to remain relatively low and manageable. Low unemployment rates and high home prices have kept charge-offs and delinquencies low. A possible deterioration in asset quality in 2025--even though it's unlikely to be severe--would raise servicers' advance liquidity requirements and reduce MSR valuations. An increase in the unemployment rate could also result in higher delinquencies.

Subdued Economic Growth Hampers Consumer Lending

Key credit drivers

Consumer credit market.  The consumer credit market remained resilient despite headwinds due to lower unemployment, lenders tightening underwriting standards, and the roll-off of the weaker 2022 vintages. For 2025, we expect that a slowing economy, a rise in unemployment, and the potential impact of new trade and immigration policies on inflation will reduce subprime consumers' purchasing power and weaken consumer credit quality. These factors will likely have an exacerbated effect on lower-income workers, who are more likely to use consumer lending products.

Profitability and funding mix.  The trade and immigration policies of the new administration could lead to inflation, which could influence future interest rate cuts. Lower interest rates typically allow for easier access to unsecured debt markets and improve the profitability of consumer lenders. Historically, higher-rated lenders (rated 'BB-' or higher) have had easier access to unsecured funding markets through a credit cycle. Positively, we expect refinancing risk to be manageable with no corporate maturities for 2025, but maturities rise to $2.5 billion in 2026.

Liquidity and weaker asset quality.  Deteriorating asset quality could translate to weaker earnings and credit metrics for consumer lenders. For lower-rated lenders (rated 'B+' or lower), we expect weaker asset quality to squeeze liquidity and cushions to maintenance covenants. If maintenance covenants for secured financing facilities are breached, lenders could lose access to the facilities and be forced to repay all borrowings under the facilities. Lower liquidity levels among lower-rated lenders could also increase the likelihood of distressed debt exchanges.

What to look for over the next year

Underlying asset quality.  We expect that consumer loan charge-offs and delinquencies will continue to remain somewhat elevated but manageable in 2025. We remain focused on trends in delinquency ratios because rising delinquencies could lead to higher net charge-offs. Deteriorating asset quality could also weaken consumer lenders' leverage, liquidity, and funding access.

Shift in portfolio mix.  Many consumer lenders have shifted their portfolio mixes by tightening their underwriting standards and focusing on originating loans to either less risky customers or more secured lending. They have also diversified their products, and some have also expanded their customer bases by offering new financing options in the form of credit cards; retail points of sale; auto loans; and lower-risk, longer-duration installment loans. We expect this trend to continue, and it should help manage asset quality risks.

Origination volumes.  In 2025, we expect that consumer demand will remain strong and that lenders will remain selective in originations and focus on either less risky customers or more secured lending. Originations and loan balances grew in 2024 despite lenders continuing to tighten their underwriting standards to manage credit quality. TransUnion, a consumer credit reporting agency, reported total unsecured personal loan balances of $249 billion in the third quarter of 2024, up from $241 billion a year ago.

Evolving regulatory environment.  Consumer lenders are exposed to ongoing regulatory risks, which can swing depending on the administration. With the Trump administration, our base-case expectation is for regulatory pressures to ease at the federal level for U.S.-based companies. However, state-level regulators could fill the void, and proposals to cap interest rates could gain momentum. Starting January 2025, the Canadian federal government has lowered the maximum allowable interest rate to an APR of 35%. We think the Canadian consumer lender we rate, Goeasy, will be able to adjust its originations in response to the regulation without materially harming its earnings or credit performance.

Interest Rates And Used-Car Prices Will Strain Auto Lenders' Asset Quality

Key credit drivers

Challenging credit quality, especially for subprime lenders.  Auto loan delinquency rates have started to stabilize, but they remain above pre-pandemic levels as borrowers continued to grapple with higher interest rates and inflation, as well as high monthly payments for auto loans and leases. We think the stabilization in delinquencies partly reflects the aging of the 2022 vintage and the stronger credit performance of the 2024 vintages. That said, a slowing economy in 2025, higher unemployment (rising to 4.5% by the end of 2025 from 4.2%), the lagged effect of higher interest rates, and a continued decline in used-car prices could continue to pose asset quality challenges for the captive and subprime auto lenders we rate.

Improved financing conditions.  In 2024, capital markets issuance recovered, with the prospect of looser monetary policy driving auto lenders to raise funding through both the asset-backed securities (ABS) and unsecured debt markets. Lower-rated subprime auto lenders primarily accessed the ABS market because the cost of funds was relatively lower than in the unsecured bond market. Higher-rated issuers, like captive auto lenders, were able to access both the ABS and unsecured markets.

What to look for over the next year

Delinquencies.  The 30-day auto loan delinquency rate showed signs of stabilizing throughout 2024, but it still exceeds pre-pandemic levels (see chart 16). We remain focused on trends in the delinquency ratio since a prolonged rise in that ratio in the first half of 2025 could foreshadow climbing net charge-offs in the second half (see chart 17), with more risk for subprime lenders than captives. We think delinquencies and net charge-offs will most likely rise as used-car prices continue to decline, unemployment picks up in 2025, and higher-for-longer rates continue to strain the ability of lower- to middle-income consumers to repay loans.

Used-car prices.  Used-car prices have fallen by nearly 20% since their peak in 2022. We expect another 4% decline in 2025 as the supply of two- to four-year-old vehicles remains tight following three years of lower original equipment manufacturer (OEM) production. As the return rate of vehicles continues to rise to pre-pandemic levels, we think auto lenders with large lease books will likely report declines in gains tied to lease residuals and could see their profitability squeezed in 2025. Among the auto lenders we rate, we believe the captive auto finance companies have the greatest exposure to leasing. Though subprime lenders have no operating lease exposure, they are not immune to the expected decline in used-car prices since they depend on recoveries through auction sales on repossessed vehicles.

Originations and financial flexibility.  Originations growth has marginally increased since the pandemic as originations across credit risk scores, at least for the first half of 2024, began to tick up from a low in 2023. While consumer demand remains strong, auto lenders tightening their underwriting standards, higher-for-longer rates, and macroeconomic headwinds from potential trade wars will limit originations in 2025-2026. We expect U.S. auto sales to grow 1%-2% over this period. These headwinds, combined with declining used-car prices, will likely hit profitability. For subprime lenders, which rely on the securitization markets at more attractive pricing than that offered by the unsecured debt market, it will continue to encumber their assets, which could limit their balance sheet flexibility in a stress scenario. We will also monitor covenant cushions because potential breaches could limit a company's ability to fund future growth while stressing its liquidity requirements.

Potential impact from proposed tariffs and regulatory scrutiny.  The Trump administration will create headwinds for the parent auto manufacturing companies. If the tariffs materialize as outlined and there is a potential rating action at the parent level, it will have a similar impact on subsidiaries we consider to be a core entity to the parent. Regulatory risk will remain an overhang for subprime lenders, and this risk will oscillate depending on the administration in power. Under the Trump administration, regulatory risks will likely diminish, but we will continue to monitor the potential outcome of existing lawsuits.

Money Transfer And Payment Services Show Resilience

Key credit drivers

Exposure to fluctuating macroeconomic conditions.  Despite posting modest top-line growth through the first nine months of 2024, Corpay's and Wex's revenues were weighed down by falling fuel prices and reduced corporate travel. The money remittance companies saw both revenue growth and earnings decline through the same period mainly due to revenue contraction in the retail money transfer channel, partially offset by strong growth in the digital channel.

Investments in growth initiatives and shareholder-friendly actions.  For most companies in the sector, investments in working capital, acquisitions, and share repurchases are still a burden on net debt levels. During the first nine months of 2024, almost all of the sector incumbents increased capital deployment through M&A and share repurchases. Larger acquisitions and opportunistic buybacks could continue to weigh on net debt in 2025 and prevent these companies from reducing leverage.

What to look for over the next year

Sensitivity to macroeconomic conditions.  Following the easing of pandemic restrictions, global discretionary travel has improved over the last few years. As a result, money transfer and payment services companies with exposure to the travel and tourism industry may continue to see revenue growth. That said, we expect it to be at a slower pace, as persistent inflation limits growth in discretionary and business travel. Companies that provide fleet fuel cards typically benefit from rising fuel prices and see revenue slow when fuel prices fall. Through the first nine months of 2024, Corpay estimates that 8% of its net revenue was directly affected by changes in fuel prices. S&P Global Ratings' base-case price assumption is that Brent oil prices will average $75 per barrel in 2025, compared with averages of $80 per barrel in 2024 and roughly $82 per barrel in 2023.

Global remittance growth.  The World Bank estimates that remittances to low- and middle-income countries increased by just 0.7% (to $656 billion) in 2023, compared with 7.7% growth in 2022. We believe that persistent inflation and exchange-rate volatility will continue to stymie growth for companies like Western Union and Moneygram in the near term. Additionally, uncertain political policy in the U.S. regarding immigrant deportations could lead to a decline in domestic outbound transactions to low-income countries. That said, the World Bank expects remittances to pick up somewhat, with remittance volumes to low- and middle-income countries growing by 2.3% and 2.8% in 2024 and 2025, respectively.

Fintech innovation.  Money transfer and payment services companies have continued to introduce adjacent financial services products into their expanding ecosystems. Most of the money transfer companies we rate have bolstered their digital platforms in recent years, with Western Union reporting that around 24% of its consumer money transfer revenue during the first nine months of 2024 was sent via its branded digital channels. Western Union, Moneygram, and Euronet's RIA business are all scaling up their digital platforms. Over the longer term, we expect the rise in fintech firms--like Wise, Remitly, and PayPal (through its Xoom service)--to challenge traditional remittance providers' transaction volume and pricing.

Capital deployment.  We expect most sector incumbents to opportunistically deploy excess capital through acquisitions and shareholder-friendly returns. We estimate that through the first nine months of 2024, Euronet, Western Union, Corpay, Wex, and Block increased their combined amount of share repurchases to around $3.0 billion, versus $1.1 billion in the same period the prior year. We also believe the sector's better-positioned incumbents will continue to make opportunistic acquisitions, and we will monitor how companies manage leverage as excess cash is depleted and debt is raised to fund buybacks and M&A.

Appendix: Rating Factor Assessments

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