Investors are watching closely for hairline cracks in the U.S. consumer loan market as low-income borrowers feel the pressure from high prices and rising interest rates.
US household debt levels have skyrocketed this year as Americans borrow more to pay for increasingly expensive homes and cars.
It’s not just about big-ticket items: Rising rents as well as rising prices at the gas pump and grocery store have pushed consumers to rely more on credit cards. Research from the Federal Reserve Bank of New York shows that US households had a record $16 billion in debt in the second quarter of this year, an increase of about $2 billion since before the pandemic.
For now, overall defaults – debt past due – remain historically low at around 2.7% and major lenders, including banks, have yet to see a significant increase in losses on consumer loans. Unemployment held steady at pre-pandemic lows and Americans continued to feel the benefits of an early pandemic revival.
But while overall delinquencies did not increase in the second quarter and are still 2 percentage points lower than they were before the pandemic, the composition has changed. According to data from the New York Fed, a growing share is now in the early stages of delinquency, which could signal developing problems. These are particularly notable in credit card loans and auto loans, where delinquencies are rising in low-income areas and among subprime borrowers.
Analysts and economists warn that these problems could proliferate as the US Federal Reserve rapidly raises interest rates to curb price growth that continues to hit 40-year highs.
Central bank tightening has yet to hit the U.S. labor market, with the unemployment rate at its lowest in half a century, but economists expect it to eventually as companies are reducing their hiring. Tighter monetary policy is also expected to make access to new credit more difficult, while borrowers face higher debt payments on credit cards and other variable-rate loans.
Figures from Dv01, a market data platform that tracks consumer loans offered by fintech companies such as SoFi, LendingClub, Prosper and Marlette, showed that new credit writedowns that have not been corrected within 30 days exceeded pre-Covid levels for the first time in May. .
Depreciation occurs when negative information about the borrower – late payments, defaults, unpaid – is added to their file.
The trend was driven by borrowers with low credit scores, but Dv01 data also indicated an increase in deficiencies among households earning up to $120,000 a year.
The outstanding loan pool tracked by Dv01 sits at around $30 billion. It’s a much smaller number compared to credit cards or mortgages, but still notable because these fintech loans are subject to ‘write-off’ – a delinquent loan flagged by the lender as unlikely to be repaid – faster than more traditional consumer loans, said Jason Callan, head of structural products at Columbia Threadneedle, potentially exposing the industry’s problems sooner.
“Most of the high-level data still looks incredibly weak. But these problems start somewhere. And as you tighten lending standards, you cut off access to credit, you charge more for that credit, leading to worse and worse outcomes,” Callan said.
Delinquency rates have also started to rise in auto loans, driven by subprime borrowers – with the rate in June at 2.7%, up 0.8 percentage points from a year ago, according to data compiled by Moody’s. Although this trend is still well below historical averages, these rates are expected to continue to rise as the latest Covid stimulus savings are reduced, according to Moody’s report.
So far, the rise in delinquencies has been too small and limited to signal a growing risk of recession. But each of these data points suggests that despite a 3.5% unemployment rate and still-strong consumption, economic strains are building up for low-income households. These tensions began as inflation eroded pandemic savings and will worsen as the Fed tightens monetary policy in a deliberate effort to cool the US economy.
The Fed is expected to raise interest rates by 0.5 to 0.75 percentage points at its next meeting in September. Evidence of a slowdown in the world’s largest economy – a second straight quarter of gross domestic product contraction reported in July – had initially prompted investors to bet the Fed would slow its pace of rate hikes in September after two increases 0.75 percentage point in June and July. However, a strong jobs report released last Friday, showing continued wage gains across all sectors, has changed the outlook for now.
“I think we’re most likely going to see an extended period of very slow growth,” said Eric Winograd, economist at AllianceBernstein.
“In this kind of environment, I would expect to see an increase in consumer delinquencies. I suspect the labor market is going to weaken. And as the labor market weakens, people are going to have to struggling to keep up to date (on the repayment of their debts).