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Is It Officially Time To Start Worrying About Consumer Credit?

Signs of increasing weakness in consumer credit have been mounting for the last several months.

Auto lending, particularly to subprime borrowers, has been looking especially concerning as delinquencies and default rates have steadily climbed. Subprime borrowers now account for roughly 20 percent of the $1.2 trillion in loans currently outstanding. Add to that the diminished value of used cars — down about 8 percent this year — and auto lenders like Ally Financial are predicting a market that will be contracting this year.

And auto lending is not the only alarm bell currently going off — student loans are also showing a spike in defaults. As of January 2016, 43 percent of borrowers were behind in their payments or had stopped making them all together. According to data released by the Consumer Federation of America (CFA) earlier this year (extrapolated from data out of the U.S. Department of Education [DoE]), 1.1 million new loans slid into default last year.

That brings the total value of federal loans originated by financial institutions (FFEL) and the DoE in default at $137.4 billion — a 14 percent increase from 2015.

“Despite a rising stock market and falling unemployment [rate], student loan borrowers are still struggling,” said Rohit Chopra, a senior fellow at CFA and a former student loan ombudsman at the Consumer Financial Protection Bureau. “The economy remains very difficult for so many young people just starting out.”

So student loans are showing a spike in default and delinquencies to match auto lending’s — and given the recently proposed changes to DoE policy, the problems for student loan borrower solvency are widely expected to get worse before they get better.

And now it seems credit cards are coming to the party — Capital One, Synchrony and Discover Financial have all increased their loan-loss provisions and reported increasing delinquencies.

So is it time to worry?

Card Weakness

Capital One’s first-quarter earnings are a good case in point, as they notched a much higher rate of loss than its management or investors were expecting.

Capital One reported a write-off rate of 5.1 percent, its highest level since 2011 .

More telling, according to market watchers, is how Cap One is explaining the apparent weakness. These days, Capital One is attributing the fall-off in loan quality to weakness in consumer behavior rather than a surge in loan growth and aging loans.

“This isn’t just a one-quarter blip. This is a change,” noted Bloomberg Intelligence’s Ryan O’Connell. “They sounded a lot more cautious on this call than they have.”

He also noted that it is of concern that consumer have run up higher debt levels of late than they have since the recent recession.

Capital One is unique among issuers with its focus on the subprime segment — a full third of their customers have below-prime credit scores. Late payments are not considered shocking or even out of the norm.

But Cap One isn’t the only issuer experience a sudden spike in losses. Discover, which is highly focused on prime and high-rated consumers — saw a similar fall-off in the quality of its card debt in during Q1 — and saw its net charge-offs rise to their highest level since 2014.

Synchrony Financial, another lender with about 30 percent of its portfolio attributed to subprime consumers, told a similar story when it reported its earnings last Friday. Charge-offs were at 5.33 percent, up 0.59 percentage point from a year prior and higher than the consensus forecast of 5.11 that analysts were looking for.

Synchrony also upped the guidance for net charge-offs on the year, saying on its earnings call that it now expects full-year 2017 charge-offs at or slightly above 5 percent. That is up from its previous outlook in the 4.75 percent to 5 percent range, which the company had only announced a quarter prior.

All three firms saw their stock price take a notable hit in the aftermath of earnings being announced.

Time To Worry?

Analysts by most reports are not exactly worried — but they are certainly becoming concerned. According to Bloomberg, there is some good news on the debt front — American household debt is on the whole declining.

The problem, according to UBS, is that data is a bit misleading — Americans are carrying less mortgage debt (because fewer people have been able to get them and lending standards have tightened), which gives the appearance of deleveraging among American consumers.

The problem is that once one subtracts out mortgage debt, UBS analysts Stephen Caprio and Matthew Mish reported last week that U.S. consumer debt, not including mortgages, now equals an unprecedented 20 percent of the nation’s annual economic output because of ballooning volumes of student and auto loans.

The same report noted that millennials as a category were the biggest potential source of weakness since they have the lowest earnings, fewest savings and so very much of the debt obligation. Millennials currently are responsible for $1.1 trillion of $3.6 trillion in U.S. consumer debt outstanding. They account for 45 percent of student loans outstanding and a third of all auto leases.

“By number of individuals, 21-to-34-year-olds were the greatest source of expected spending on big-ticket purchase items over the next 12 months. However, this is where default risks were highest,” noted the recent UBS report.

Notably, UBS doesn’t think the growing risk of default is not a systemic risk — yet — but it is concerned that the markets are not taking said risk seriously. Stock prices for card firms, particularly those service subprime clients, have started declining in the past few weeks, despite the fact that default issues have been observable for the last few months.

But the bigger worry, among analysts and investors alike, is how deep consumer credit weakness may grow. Issues now are more or less concentrated in the subprime and near-prime lending categories. The year, however, is young. Other credit surprises, according to USB, may still be in the offing.

And it doesn’t appear that anyone is expecting them to be pleasant surprises.

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