• When consumers pay the bills, some bills will reliably get paid first while others last. In consumer lending, this is called the household payment priority waterfall. Where obligations sit in the payment priority waterfall can make a material difference in credit performance, particularly during stressed economic periods.

  • The payment priority waterfall provides clear indications of the inherent risk of consumer lending verticals in Australia, but it also provides a guide to SME borrower risk when that ‘consumer’ is also an SME owner/director and borrower. More specifically, when that owner is delinquent on certain consumer debt/service bills, it is empirically shown to be an indicator of heightened SME debt repayment risk, with the key person generally being highly connected to business performance.

  • The casual observer may think that once a borrower in a portfolio either moves into or shows signs of heightened risk of delinquency, there is not much the private debt fund manager can do. But in the case of personal lending funds and SME warehouse structures, either the first loss provision (personal lending) or the first loss equity note (warehouse structures) can be dynamically managed to a degree (increased, for example) to mitigate any heightened risks. Furthermore, within an SME warehouse, the fund manager can tighten lending parameters and make tactical tilts away from certain borrower segments to address perceived heightened credit risk. Given the short-to-medium-term nature of most loans, these adjustments are made easily through term-outs and refinancings.

  • We examined real data in relation to a hierarchy of debt (seniority) and bills’ first-to-default risk (default propensity) and how it serves as an indicator of changing borrower delinquency risk (risk drift). The analysis highlights the necessity for adept personal and SME loan portfolio management and more sophisticated credit assessment and monitoring systems, above and beyond a credit score at the time of loan origination. This line assessment has been an increasing focus for Foresight Analytics and Ratings when reviewing personal lending funds and SME lending vehicles in the Australian private debt sector.

Australian Household Payment Priority Waterfall – Implications for the Personal and SME Private Debt Segments

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