Rising Defaults May Give Misleading Picture on Consumer Health

Obsessing over “vintage” isn’t just for wine enthusiasts or hipsters. It is also a crucial part of understanding what is happening in credit. And it may help tell a more constructive story about American spenders.

Many measures of credit performance for things such as credit-card or auto loans are moving in the wrong direction, like the percentage of payments that are late, or the share of debts being written off. For example, in Discover Financial ServicesDFS 0.34%increase; green up pointing triangle latest quarterly report, the lender guided toward a jump in net charge-offs from 3.42% in 2023 to a range of 4.9% to 5.3% in 2024. Discover shares tumbled more than 10% on Thursday.

At the same time, though, there are many other indicators suggesting strong consumer health, such as buoyant spending numbers. And the biggest banks, with detailed insight into the day-to-day finances of millions of people, haven’t sounded alarm bells, either. “The consumer still has plenty of firepower,” Bank of America Chief Financial Officer Alastair Borthwick told reporters.

So is there a way to reconcile all of this? Digging into recent reports by consumer lenders suggests that there is. Higher net-charge offs in 2024 may in part be a reflection of a unique growth in credit that happened in the aftermath of the Covid-19 pandemic.

During the pandemic, some Americans saw improved finances. They spent less, received government stimulus and enjoyed forbearance on some payments. Measures of creditworthiness improved. According to Charlie Wise, senior vice president of research and consulting at TransUnion, “many consumers migrated to better risk tiers during the period from 2020-2022.”

As the economy reopened, lenders were eager to tap in to the surge of potential spending, sending out waves of credit offers. In the period from June 2021 to June 2023, just over 12 million additional consumers who before that didn’t have a credit card got access to one or more, according to Wise.

Then 2022 brought a swell of inflation, to levels not seen in decades. And the Federal Reserve began driving up interest rates, making things like floating-rate card loans increasingly expensive. The upshot is that so-called “vintages” of loans from that period have seen unusual late-payment and loss rates. 

Ally FinancialALLY 10.71%increase; green up pointing triangle, a major auto and consumer lender, said on Friday that for retail auto credit its “2022 vintage, more specifically the second half of 2022, is showing elevated loss content versus expectations.” However, executives also told analysts that “we feel our underperforming originations are ringfenced to the second half of 2022,” in part reflecting subsequent credit tightening.

Ally said it anticipates its seasonally adjusted peak of retail-auto loan net charge-offs will be in the first half of 2024. It noted that its 2023 vintage loans had a 30-day-plus delinquency rate of 2.23% after 12 months—below the 2.45% rate for 2022 loans after the same period of time.

Discover executives told analysts on a call that a year-and-a-half to two years ago, inflation was outpacing wage growth, which put “the lower quartile” of consumers “in a significant amount of stress.” Combined with the large size of the 2021 and 2022 vintages, that contributes to charge-offs that will “peak before they normalize back to levels that you’re accustomed to seeing from Discover,” they said. Executives expected charge-offs to plateau, and then “step down” beginning in 2025.

So what is happening to many loan books may ultimately be as much a story about lenders as it is about consumers. If the population of people who got loans or cards, and used them heavily, was different than it was in past years, then just comparing today’s loss rates to prepandemic isn’t going to give a very clean indicator of overall consumer health. 

It also suggests that 2024 could represent a nadir for credit that lasts a relatively short amount of time. Consumers might just keep buying pricey old bottles or vinyl records for a while longer.

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