An ominous trend, indicating US consumers are in far worse shape than assumed by conventional wisdom, has re-emerged.
Regular readers may recall that two years ago we wrote that "Credit Card Defaults Surge Most Since Financial Crisis." And while this deteriorating trend had more or less plateaued for much of 2018, it has taken another big step higher and as Bloomberg reports "red flags are flying in the credit-card industry after a key gauge of bad debt jumped to the highest level in almost seven years."
According to advance data from Bloomberg Intelligence, which will soon flow through to the S&P/Experian Bankcard Default Index, after staying largely flat for much of 2017 and 2018, the first three months of 2019 saw a troubling jump in the nationwide credit card charge-off, or default rate to 3.82%, the highest in seven years or since the second quarter of 2012. At the same time, the number of loans 30-days past due, a leading indicator of future write-offs, jumped at all seven of the largest U.S. card issuers.
Some examples: Capital One said this week that its first-quarter U.S. card charge-off rate climbed to 5.04% from 4.64% at the end of 2018. At Discover Financial Services, which also reported results on Thursday, the charge-off rate rose to 3.5% from 3.23% in the prior quarter.
As for what is causing this sharp jump in charge offs, some credit card issuers blamed artificially increased FICO scores. As readers may recall, two weeks ago we asked if "Inflated" FICO Scores Will Be The Catalyst For The Next Meltdown" noting that credit score inflation "is the idea that debtors are actually riskier than their scores indicate, due to metrics not accounting for the "robust" economy, which may negatively affect the perception of borrowers' ability to pay back bills on time. This means that when a recession finally happens, there could be a larger than expected fallout for both lenders and investors."
There are around 15 million more consumers with credit scores above 740 today than there were in 2006, and about 15 million fewer consumers with scores below 660, according to Moody’s.
The problematic implication is that while FICO scores may represent a far stronger US consumer, the reality is just the opposite, as Capital One implied during its Thursday conference call, when Richard Fairbank, CEO of Capital One which is the country's third-largest credit card issuer, warned that there’s been a "degradation" in credit quality for certain customers, adding that "some customers with negative credit events during the financial crisis are now seeing those problems disappear from their credit-bureau reports." And yet, the same customers are just as unlikely to repay their credit card bill whether their FICO score is 750 or 680.
"We may be looking at data that might not paint the full picture of a consumer’s credit history," Fairbank said during the Thursday earnings call with analysts. "Part of the context for our caution has been not only how deep we are in the cycle but, also, this is the time period when there is less information than there once was."
Did someone say non-GAAP credit scores? Because that's precisely what the artificially inflated FICO scores have become, and they are presenting an unreliable picture of a customer's ability, or eagerness, to pay down their credit card debt. Hence the jump in charge offs.
Others echoing the warning included the CEO of Discover Card, Roger Hochschild, who said that "certainly, this has been one of the longest recoveries, so, in general, we have been contracting credit policy at the margin and tightening." In an interview with Bloomberg, Hochschild said his company has been closing inactive accounts and slowing down the number and size of credit-line increases for both new and existing customers.
Almost as if those artificially higher non-GAAP FICO scores no longer represent reality... just like non-GAAP financial results.
Meanwhile, as Bloomberg adds, the credit card industry’s latest warnings build on developments in January, when fourth-quarter results showed charge-off rates near the lowest in decades were coming to an end, something we discussed at the time. As a result, competition for the highest-quality customers remains fierce, leading many issuers to spend more on marketing and rewards to gain market share with that group.
“If you think about lending products, there are always people who want to take your money,” Hochschild said. “You’re going for people who have many choices -- they have existing cards, they could get any card they want. So our job is to make sure those are the ones we attract to Discover.”
But a growing wariness about the potential for a rise in bad debt has led many issuers to tighten underwriting and to make issuance of new credit more problematic, creating a vicious loop where those who need credit the most are also the least likely to get it.
That said, it's certainly not a crisis yet: charge-offs remain not far from historic lows as banks benefit from low unemployment rates in the US. On the other hand, with overall interest rates in the US still near historic, record lows, the fact that charge offs are already surging is just another reason why the Fed will find it impossible to hike rates higher, and in fact, if the deteriorating default trend continues, the central bank may have no choice but to cut rates soon. And while that may kick the can for a few quarter, all such a goosing of US consumer will achieve, is make the next recession - and financial crisis - that much worse when it finally hits, because if American's can make their credit card payment when unemployment is a record low and GDP is - allegedly - growing above 3%, one wonder what will happen when the next recession does finally hit.