The return of credit risk does not have to be an unwanted sequel
Consumer credit risk was on the decline in 2021. It could start to return next year, but not necessarily in a way that should still worry banking investors.
The average rate of overdue payments rose from October through November for loans from six major credit card banks, according to master trust figures compiled by S&P Global Market Intelligence. The same is true for the average rate at which bad debts were debited. The increases were fairly small: write-offs fell from 0.9% to 0.95% of loans, and delinquencies fell from 0.8% to 0.82%. And these levels are still very low, about half of the levels they were two years ago.
Still, analysts at Moody’s Investors Service wrote in December that “the unusually strong quality of consumer loan assets has reached a turning point,” with delinquent payments and written off loans starting to rise as support measures like the stimulus retreated. They noted pressure on some tenants to end the moratoriums on evictions.
At the same time, many also expect a slow and steady return to normal. Moody’s does not expect bank credit card or auto loan write-offs to peak until 2023. Americans generally have a lot of home equity in their homes right now, and mortgage lenders are keen to top up the debt. volumes with cash refinancing products. Used car values also remain high, supporting both consumer balance sheets and bad debt collections. A tight job market could also help people avoid the types of prolonged unemployment that make credit problems worse.
There may be markers along the way that could indicate that things are not going as smoothly, such as if people’s relatively high savings are quickly running out and leading to increased non-payments. Perhaps there are also effects of the Covid-19 Omicron variant, which has interrupted some businesses and works but has not yet been accompanied by any stimulus.
In any event, investors should also assess the effect that a small increase in credit losses would have on lenders’ profits. Banks still have relatively large loan loss buffers. This is due to the large reserves added in 2020 and a new method of accounting for loan losses that came into effect for many banks at the start of this year. Thus, banks may not have to make unusual provisions in earnings even if credit deteriorates from there.
Provisions for losses as a percentage of loans and leases at major U.S. banks have declined nearly a percentage point from their peak of 2.6% in 2020, according to Federal Reserve figures. But they are still almost half a point above what they were at the end of 2019.
Then there is the growth of loans. The net interest income of banks as a whole could increase further, as they earn it on a larger amount of borrowings. And, if the Fed raises rates, most credit card rates go up automatically, which usually inflates bank margins. Losing money is easier to manage when there is just more to do.
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