With credit card data in for Q2 2017, American households look to once again be on a collision course with the ever-elusive $1 trillion goal that narrowly escaped their clutches in 2008. With nearly $940 billion in credit card debt outstanding, 2Q 2017 marked the second highest consumer revolving debt balance since the previous peak in 2008. Per WalletHub:
All of which adds up to nearly $8,000 of credit card debt per household, up 5% YoY versus flat-ish wages.
Of course, the more surprising component of the 2Q 2017 credit card data is not that banks continue to trip over one another for the 'opportunity' to underwrite Americans' purchases of fidget spinners, but rather that they continue to do so despite the rather ominous recent rise in charge-offs.
Not surprisingly, Morgan Stanley recently noted the same trend in subprime credit card delinquencies...which they apparently found staggering in light of the fact that 'everything is awesome' in the job market.
Of course, after spending the entire month of August analyzing those seemingly contradictory facts, Morgan Stanley came to many of the same conclusions that we note a regular, recurring basis. Apparently, soaring credit card delinquencies have something to do with stagnant wages in the face of soaring healthcare costs and rising rents...who could have guessed that?
Investors ask, "Why are card losses rising if employment is so good?" Our deep dive & quant work shows subprime is stretched from higher rent, healthcare costs & low wage growth, with lower credit availability a coming drag.
A Tale of Two Consumers, with the subprime consumer increasingly at risk, driving up net charge-offs (NCO) and lowering EPS: The economy is solid and unemployment is very low, but credit card delinquencies have been increasing... so we spent the month of August delving into what is really going on with the US consumer. We found that the average consumer is in good shape but the financial pressures on subprime consumers are high and, critically, rising
1. Banks are pulling back on subprime card loan growth. For the past 3 years, bank lending to subprime card posted an 8% CAGR, faster than prime's 5% growth. But banks are now beginning to put on the brakes. Subprime loan growth has slowed over the past two quarters to 10% y/y in 2Q17, down from 13% y/y peak in 4Q16. Our quant work shows a negative correlation between change in loan growth and change in losses. Result? Expect declining subprime loan growth to drive up subprime losses over the next 12 months.
2. Rent and healthcare costs a bigger burden for lower income consumers… and rising. Consumers in the lowest income quintile spend 38% of after-tax income on rent and another 18% on healthcare costs, a combined 56%. This is well above the average consumer's 40%. Pressures are building on both. Our REIT colleagues expect rental rates on mid- to low income apartments, Classes B & C, will continue to rise from already high levels, but at a decelerating pace. Our healthcare colleagues expect healthcare costs to rise ~5% annually over the next few years. These costs put more pressure on lower income consumers, who have lower wage growth.
3. Discretionary income not keeping up with debt service burden growth. Debt service burden (interest and principal repayment) is growing 2%, faster than the 1% growth in discretionary income for the average consumer. That means, after paying for basic needs like shelter, food, healthcare, and utilities, there is less left over to pay back lenders. Middle income renters are in the toughest spot as it looks like their borrowing has accelerated in auto, student, and personal loans, while their disposable income growth has been below average. The lowest income quintile is burdened by high and rising rent and healthcare costs.
Ironically, after declining for decades, Morgan Stanley presents the following chart which reveals that healthcare costs as a percent of disposable income started consistently rising again only after the passage of Obamacare. Meanwhile, soaring apartment rents are also wreaking havoc on disposable income for middle-class families.
Meanwhile, despite a "strong job market", debt payments can only continue to grow at a faster rate than income for so long before it starts to take a toll on overall credit performance.
Alas, all things that Yellen & Co. can cure with some more rate hikes...