While 23 states could already be in recession, the impact on credit data may be slow to filter through. — Bloomberg
American consumers are feeling downbeat. Their sentiment is at one of its lowest levels in 73 years, according to the latest University of Michigan survey.
A separate question in the same survey shows unemployment-rate expectations for the next year are as bleak as any non-recession period since 1978. Yet for all the gloom, consumer credit is holding up.
“When you look at it, you see really strong credit results,” Wells Fargo & Co chief executive officer Charlie Scharf told investors on his earnings call this month.
“You see strong consumer spend and stable deposits and those things just kind of paint a picture of a consistently strong consumer, even though what you read about would lead you to believe that they’re being more cautious.
“Our results just say that there’s a high degree of consistency there without any real pockets of slowing,” Scharf said.
Indeed, among banks and credit-card issuers that reported earnings over the past two weeks, card losses came in uniformly lower than analyst estimates. In many cases, banks even released reserves they’d put aside for a potential consumer slowdown.
With monthly delinquencies running lower than at the same point last year, the immediate outlook seems rosy – in contrast to the experience in several banks’ commercial loan books where cockroaches have recently emerged.
So how to explain the divergence between sentiment and credit performance?
One explanation lies in the “K-shaped” theory of the economy. If the top 10% of earners are behind roughly half of all US consumer spending (up from about a third in the early 1990s) then economic indicators become less sensitive to the behaviour of the majority.
So while 23 states could already be in recession, representing a third of gross domestic product, according to economist Mark Zandi, the impact on credit data may be slow to filter through.
But that’s not what lenders are seeing. “Subprime, almost always we find, is the segment that sort of turns first,” said Richard Fairbanks, chief executive of Capital One Financial Corp, on his earnings call.
“But we are finding in our own subprime performance, subprime credit performance is moving in line with prime.”
And although American Express Co, whose customers sit at the apex of the “K”, was especially upbeat, Synchrony Financial, many of whose customers sit on the bottom leg of the “K”, was no less sanguine.
“When we look at the payment strength of non-prime borrowers, when we look at the payment engagement, whether it’s values or frequency, they are performing better than some of the other cohorts,” said chief financial officer Brian Wenzel.
Another explanation is that lenders are getting better at tweaking underwriting criteria to respond to economic conditions.
Coming out of the pandemic, many underestimated the extent to which stimulus payments and relief plans helped the consumer. Loan vintages in 2022 paid the price.
Ally Financial Inc saw delinquencies on auto loans originated in that period shoot up to 3.76%, 18 months out.
Having tightened its criteria, losses on 2024 and 2025 vintages are back to a more benign level of about 2.7%.
“That’s giving us a benefit in terms of vintage rollover that, quite frankly, still has some legs to it,” said chief financial officer Russell Hutchinson on his call.
Third, although unemployment is a strong driver of credit quality, what matters more is the flow of newly unemployed.
Because of the government shutdown, we haven’t had an update recently, but when the Bureau of Labor Statistics last released data, the number of people unemployed for five weeks or fewer was running flat; any increase in the unemployment rate was due to a swelling in the ranks of the long-term unemployed.
Of course, none of this means risk is entirely mitigated. Economic conditions could catch up with sentiment.
“If people lost their job, they go through severance, they go through unemployment, then they go through the struggle. So there’s always a lag with regard to unemployment,” said Synchrony’s Brian Wenzel.
One thing to watch is loan growth. With so much uncertainty, it may not be an opportune time for lenders to push credit onto their customer base.
In fact, loan growth among major card issuers was weak in the third quarter, in some cases as part of a deliberate pullback.
Capital One, which recently bought Discover, is explicitly disinvesting from high-balance revolvers, a segment it says fared worst in the 2008 recession, after Discover had built share in that segment.
Bottom line: Sentiment is sour and unemployment worries are rising, but bills are being paid. If job losses broaden, losses will follow. For now, lenders’ restraint on growth and discipline on risk are buying time. — Bloomberg
Marc Rubinstein writes for Bloomberg. The views expressed here are the writer’s own.
