Consumer pessimism, inflation heighten credit concerns for banks

Decades-high inflation has U.S. consumers feeling more pessimistic than they have in years, raising concerns that they may ease up on spending or fall behind on credit card payments.

As banks start reporting their quarterly earnings Thursday, analysts are monitoring any signals executives may send on consumers’ health and whether it is pointing to a looming recession. 

Despite the decline in consumer confidence and rising recession risks, other economic data is countering the notion that a major slowdown is underway. The U.S. added 372,000 jobs in June, consumer spending has largely held up and, on average, individuals continue to have significant savings buffers that may help ease any financial pain.

But many lower-income people have smaller buffers, and they are being hit harder by rising prices on food, energy, housing and other critical needs. Inflation rose by 9.1% in June compared with a year earlier, and it has led to a large plunge in consumer confidence.
For example, 53% of credit card borrowers told LendingTree in June they were confident they could pay their next statement in full, down from 63% in the prior month’s survey.

“Inflation, higher interest rates and general economic uncertainty is starting to take its toll on credit card holders,” said Matt Schulz, chief credit analyst at LendingTree.

Investors appear to be preparing for a rockier economic environment, driving down stock prices for credit card companies such as Capital One Financial and Synchrony Financial. The KBW Nasdaq Bank Index is down more than 25% this year, underperforming the broader market.

Markets are taking a harsher view on lenders who focus more on subprime borrowers. One online lender, Upstart Holdings, has seen its stock fall by more than 80% this year and said Friday that its funding is “constrained” as large investors looking to buy up its consumer loans take a more cautious view.

Economists are also growing more concerned about a possible recession. Bank of America’s economics research team, for example, said on Wednesday it now expects a “mild recession” in the second half of this year since economic momentum has slowed “more rapidly than we previously expected.”

Analysts expect consumer lenders to see strong loan growth in the second quarter, partly thanks to consumers running up their card balances again after spending much of the pandemic paying them down.

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But one key question is what exactly is driving the increase in borrowing, according to John Hecht, a consumer credit analyst at Jefferies. Is higher borrowing a healthy sign of an economic rebound and increased demand, or is inflation straining consumers and leading them to use their credit card more often?

“Reality is likely between the two,” Hecht wrote in a note to clients, adding that “some investors believe this growth may be a red flag.”

Strained budgets for consumers are a problem for lenders, making it more likely that they will have to write off loans that people can’t pay.

Credit concerns were almost nonexistent for much of the pandemic, as people used stimulus and larger savings to pay their credit card and auto bills and some benefited from forbearance programs. But delinquencies have started to return to more normal levels, particularly among consumers with below-prime credit scores. 

Some analysts remain optimistic that credit normalization will remain just that — a return to more usual credit metrics rather than a sharp uptick in losses.

“Although we have respect for the risks that could be ahead if economic conditions and unemployment deteriorates, our current view is that challenges are manageable,” RBC Capital Markets analyst Jon Arfstrom wrote in a research note. He pointed to consumer balance sheets remaining healthy and continued gains in the job market, which keeps income flowing to consumers.

But Morgan Stanley analyst Betsy Graseck took a dimmer view of bank stocks, saying in a note recession risks should mean “taking some consumer chips off the table.” 

“While we expect consumer subprime losses will have increasing losses, what’s less clear is the trajectory of higher-end consumer credit quality as inflation persists,” she wrote in a research note, adding that investors and bank executives “haven’t seen this level of inflation in 40 years.”

The next three quarters should give bankers and investors more clarity on where credit quality is heading, particularly as consumers work through likely higher energy costs this winter.

But even as consumer credit stocks fall, Graseck wrote, it’s “hard to argue for buying the dip because the credit cycle has not yet really started to play out yet.”