As U.S. banks head into earnings season, growing fears about a potential recession are raising questions about how long positive trends in consumer credit can last.
Late payment rates on credit cards, auto loans and other consumer loans have been gradually ticking up for months, but lenders have so far described the trend as normalization following a period of unusually low delinquencies earlier in the pandemic. The prospect of a faltering economy could change the equation.
Third-quarter earnings season kicks off next Friday — JPMorgan Chase, Citigroup and Wells Fargo are among the banks that are scheduled to report that day — and industry observers will be watching for signs of distress.
Overall, consumers are still healthy and credit performance in the credit-card industry is "stronger than it was before COVID perhaps," said Pedro Sancholuz Ruda, a senior credit officer at Moody's Investors Service.
"But the positive trends we've been seeing are starting to erode, and the pressure is going to start building," he added.
In recent months, banking executives have mostly been upbeat about their consumer loan portfolios. They have noted that consumer stress has been more pronounced in the subprime sector, where banks generally have less exposure than other consumer lenders.
The job market has largely stayed on track so far; the U.S. unemployment rate ticked up to 3.7% in August. But as the Federal Reserve's rate hikes start to cut into demand, there are "some early signs that the labor market is beginning to cool," according to Bank of America analyst Mihir Bhatia.
High unemployment has historically coincided with consumer credit troubles, as lenders charge off loans that they think their out-of-work customers can no longer repay.
"With the Fed signaling it is willing to endure a weaker labor market to bring inflation in-check, we think there is more credit weakness to come and we are increasing our loss forecasts" for 2023 and 2024, Bhatia wrote in a note to clients that focused on credit card companies.
The good news for lenders is that they have largely held onto or even ramped up their loan-loss reserves, and appear well prepared to absorb some blows, Bhatia wrote.
Delinquency rates at three major credit card issuers — American Express, Capital One Financial and Discover Financial Services — remain below pre-pandemic levels but have been rising at a "modest" pace, according to a recent note from Moody's.
In August, late payments of at least 30 days accounted for an average of 1.97% of credit card loans at Amex, Capital One and Discover, up from 1.82% in July, but down from 2.61% from August 2019, Moody's said.
Credit card borrowers have paid off unusually large portions of their balances during the pandemic, but are now reverting to more traditional payment patterns, thanks to a combination of waning government relief, rising interest rates and inflation that's sopping up some of the excess liquidity that consumers built up during the pandemic, according to a recent TransUnion study.
With less liquidity, a portion of those borrowers are now growing their credit card balances and their credit lines, while also making smaller monthly payments, or, in some cases, not paying at all, the study found.
Those trends mean that delinquency rates, which are below pre-pandemic levels for now, may not stay there for long, said Paul Siegfried, card and banking business leader at TransUnion.
"I think many consumers are at least as well, if not better, off than they were before the pandemic," Siegfried said.
"But there's a subset of consumers who are really at risk," he added, pointing to low-income borrowers as well as those who live on fixed incomes.
Subprime borrowers are another source of concern at consumer lenders. Their delinquencies and charge-offs
Doug Shulman, CEO of the subprime consumer lender OneMain Holdings, said last month that "everyone saw a spike in delinquency" this spring, which prompted OneMain to tighten its credit criteria.
"If you don't have as much cushion and you have an increase in basic living expenses — gas, housing, utilities, food, those kinds of things — you start to have to triage, and some people are having trouble paying," Shulman
Meanwhile, credit quality for auto loans is also "continuing to deteriorate faster than cards," Moody's analysts wrote last month. The Moody's analysts believe that banks' auto loans portfolios may face headwinds if used car prices decline.
Record-high used-car prices during the pandemic — driven by high consumer demand and a chip shortage that hampered new vehicle production — have helped auto lenders' credit performance by inflating the value of repossessed cars.
But used-auto prices "have been moderating over the last several months and are becoming a headwind for auto loan asset quality," the Moody's analysts wrote. That softening may continue as the chip shortages get resolved, and higher interest rates make it less feasible for consumers to buy cars, they added.
