By many measures, the economy looks strong.
The stock market — despite a fairly steepWh correction a week ago — is still well ahead of where it was a year ago and is trending up. Unemployment is at historic lows, wages are rising given the tight labor market and consumer spending has been keeping pace.
Dig in a bit deeper, however, and the numbers become a bit less confidence-inspiring, since the bulk of that consumer spending is being done on credit, as household debt is skyrocketing.
That by itself isn’t worrisome news: Credit can be useful leverage if used correctly. But the data indicates that for an increasing number of users, debt is not being managed correctly. Late payments and out-and-out defaults and charge-offs are on the rise across a few lending segments.
Rising Consumer Debt
According to the New York Federal Reserve, household debt surged in the final quarter of 2017 to $13.15 trillion, a $193 billion increase from Q3 and $402 billion higher than the fourth quarter of 2016.
A fair portion of that interest rate, according to the Fed, was an uptick in mortgage lending.
The NY Fed additionally reported that consumer credit (credit figures that do not include real estate debt) rose by $27.95 billion from the previous month, the largest increase in 16 years. That increase was about $10 billion more than what experts had predicted.
All in, consumer credit debt grew 8.83 percent in 2017, its quickest uptick in two years. Revolving outstanding credit, made up primarily of credit cards, increased at a 13.3 percent annual pace in November, while non-revolving outstanding credit, mainly student and auto loans, grew 7.2 percent annually.
As consumer borrowing was spiking, consumer confidence was falling, after hitting a 17-year high water mark in Nov. 2017.
At the time, that dip was shrugged off since the overall trend was positive. Lynn Franco, director of Economic Indicators at The Conference Board suggested the drop in confidence was the result of a “less optimistic” short-term outlook for business and job prospects.
“Despite the decline in confidence, consumers’ expectations remain at historically strong levels, suggesting economic growth will continue well into 2018,” she said.
Credit Card Troubles
The overall picture for credit card debt going into 2018 reflects a consumer in stress — a rising number of late payments and defaults than in year’s past and over a far greater diversity of lenders.
Capital One, for example, opened the year with earnings that reflected higher quarter-over-quarter and year-over-year defaults, and a jump of 5 percent in credit loss provisions.
Store-card issuers Synchrony and Citibank reported a similar issue: Loan volume was growing, but defaults were too. Citibank’s store-branded card portfolio, for example, is expected to see a charge-off rate of about 4.6 percent in 2018 — up from the 4.32 percent previously forecasted.
An overextended consumer is starting to appear at lenders like Chase and Bank of America, which have historically focused their attentions on prime borrowers with solid credit scores.
In fact, earnings results show that the four largest U.S. retail banks indicate an almost 20 percent increase in credit card losses across the board during 2017.
“People are using their cards to get from paycheck to paycheck,” said Charles Peabody, managing director at the Washington-based investment group Compass Point, according to a report in The Financial Times. “There’s an underlying deterioration in the ability of the consumer to keep up with their debt service burden.”
Last year, Citigroup, JPMorgan Chase, Bank of America and Wells Fargo suffered a combined $12.5 billion in losses from delinquent credit card loans — roughly $2 billion more than were on the books at the end of 2016.
Issuers said the culprit wasn’t a degradation of the borrower profile, but simply an uptick in an otherwise low default rate. Those increases, they contended, were mostly cyclical in nature.
Marianne Lake, JPMorgan CFO, told investors at its last earnings call that the trend did not reflect a “deterioration” but “a seasoning and maturation of the newer vintages (of card debt) and growth.”
Auto Loans Exploding (and Imploding?)
The trouble in the auto lending segment is a story of the subprime borrower — something that seems to be getting worse.
The nation’s two largest subprime auto lenders — Credit Acceptance and Santander Consumer — began the year with the announcement that both would have to put aside larger than anticipated sums to cover loans gone bad.
Both said subprime auto loans were going south at a rate nearly twice that of prime borrowers and that subprime lending remained firmly entrenched as the fastest growing part of the auto lending segment.
“Investors had thought we had turned a corner and that things would be improving in 2018,” said Vincent Caintic, analyst at Stephens. “It sounds like that may not be the case.”
Santander Consumer put aside $562 million for bad debts, which was actually less than it had put away during the same period a year ago. And while that drop-off from $686 million is good news, the Q4 count was an increase over the $536 million Santander put away in the third quarter.
“The overall macroeconomic environment remains stable and supportive for our business. Consumer confidence remains high,” noted John Rowan, analyst at Janney Montgomery Scott.
Unlike the other forms of debt — where delinquencies have started to tick up after a long period of falling or staying at historically low numbers — the default rates for student loans have been bad news since the recession.
Some predict that it may be about to get much, much worse.
Right now, roughly 11 percent of student loan debt is more than 90 days delinquent. About half of the nation’s $1.4 trillion in student debt is held by borrowers who are still in school (or unemployed or disabled or one of a handful of conditions that allows one to defer payment without penalty) and are thus not required to pay.
In reality, the share of delinquent student debt likely stands at 22 percent, the New York Federal Reserve said.
And student loan delinquency, noted The Wall Street Journal remains the most puzzling and intractable form of lending for economists, because it seems so stubbornly uncorrelated with employment figures. Millennials are objectively more likely to have full-time employment now than they did five years ago, and yet they seem no more likely to pay their debts.
That issue is taking its toll on lenders who specialize in student financing — even student lending among “prime borrowers.”
SoFi is a private company, so there are no public earnings records to review, but in a letter to shareholders reviewed by The Wall Street Journal, the lending startup indicated it failed to meet its own internal projections for the fourth quarter, in part because of the markdown of personal loans, which it said had “lower-than-expected credit performance.”
SoFi lends outside student loans — having expanded into personal and mortgage lending the last few years — but student loans remain the core of their lending business.
Among changes SoFi is advertising for 2018? Improving upon its model for determining creditworthiness.
That’s a jump ball. It’s possible the end of 2017 was a blip and consumers got a bit overzealous with the holiday spending — and needed a bit of early 2018 to get things right. And, of course, all data has a rearview mirror aspect to it.
There’s some evidence that this may indeed be the case — along with other evidence that tailwinds may keep the spending spigot set to “on.”
The wealth effect remains in place as stock markets remain in a (generally) upward trend, volatility notwithstanding, having seemingly digested the specter of inflation that roiled and rattled investors a week or so ago.
The tax cuts enacted last year also may make consumers more prone to consumption, with a bit more in the till to dole out to retailers and sundry merchants.
The only persistently troubled sections are subprime credit and auto lending — and subprime lending is by nature prone to higher defaults.
So, in this case, all proceeds apace — a pace, of course, that remains to monitored.