Garnet Capital Advisors Blog

November 7, 2022

Consumer Borrowing Up, as Well as Delinquencies; Loan Sales Can Help

Savvy bankers understood that record-low delinquency rates on consumer loans couldn't last forever. With consumers spending their stimulus funds and inflation putting pressure across the board, the inevitable increase in consumer delinquencies appears to have begun.

The trend so far appears to be more prominent in the subprime sector, where banks hold less exposure than other consumer lenders. But if the jobs market begins to falter and the U.S. appears to be headed toward a recession, delinquency rates are likely to increase across the board. 

While banks have largely maintained or increased their loan-loss reserves to prepare for this anticipated scenario, now also might be a good time to improve the books by selling some distressed loans or those with the potential to falter soon.

Where Consumer Debt Stands

Total household debt increased by $312 billion in the second quarter of 2022, according to the Federal Reserve Bank of New York, with mortgage debt representing the biggest chunk at $207 billion. However, credit card balances also jumped by $46 billion over the previous quarter, and auto loan balances increased by $33 billion.

The Fed attributed much of this increase to rising prices across all three sectors. "In fact, the average dollar amount for new purchase originations of both autos and homes is up 36 percent since 2019," the Fed noted.

The overall consumer debt of $16.15 trillion represents a $2 trillion increase over the fourth quarter of 2019, the last quarter before the beginning of the pandemic.

The quarterly increase in credit card debt also is the largest increase recorded by the Fed since it began tracking the numbers in 1999, which it also attributes to higher prices for consumer goods and services paid for with credit cards.

The increased borrowing also comes at a time when delinquency rates are starting to creep up from their record lows, particularly among borrowers with lower credit scores. Credit card delinquency for subprime borrowers has risen from 1.9 percent in the first quarter of 2021 to 2.4 percent in the second quarter of 2022, while auto loan delinquencies have risen from 1.7 percent in the third quarter of 2021 to 1.9 percent.

Overall delinquency rates have risen from a record low of 1.45 percent in the second quarter of 2021 to 1.71 percent in the second quarter of 2022, reports the Federal Reserve Bank of St. Louis. Though that is still below the level of 2.45 percent in the third quarter of 2019 and the 20-year high of 4.44 percent in the fourth quarter of 2009, the rate has been trending up since the second quarter of 2021.

What Rising Delinquency Rates Mean for Banks

Subprime lenders have been the first to see the effects of rising prices, stimulus payment cessation, and higher interest rates. Subprime borrowers are the first to show the effects.

"If you don't have as much cushion and you have an increase in basic living expenses — gas, housing, utilities, food, those kinds of things — you start to have to triage, and some people are having trouble paying," Doug Shulman, CEO of subprime consumer lender OneMain Holdings, told American Banker.

Lenders consider the current uptick a normalization after the record low delinquencies, but certainly, a trend to keep an eye on.

Overall, consumers are still healthy and credit performance in the credit-card industry is "stronger than it was before COVID perhaps," Pedro Sancholuz Ruda, a senior credit officer at Moody's Investors Service, told American Banker.  "But the positive trends we've been seeing are starting to erode, and the pressure is going to start building."

Paul Siegfried, card and banking business leader at TransUnion, concurred: "I think many consumers are at least as well, if not better, off than they were before the pandemic. But there's a subset of consumers who are really at risk." He classified those at risk as low-income borrowers and those on fixed incomes.

The risk grows for banks as the economy responds to the Fed's effort to brake high inflation with rising interest rates. If the braking becomes too hard, the country could fall into recession and companies will begin laying off workers.

Rising unemployment historically links with consumer credit difficulties, because lenders will charge off loans when borrowers who lose their jobs cannot repay their loans. 

Pressure could be stronger this cycle in the auto loan sector if used car prices decline, as many experts expect. As the chip shortage for new cars winds down, more inventory will become available, which would decrease demand for used cars and likely lead to price drops. Lenders have received inflated prices for repossessed vehicles, as a result, but that advantage would disappear if used car prices slip back to more normal levels.

Borrowers also could fall underwater on their auto loans if the value of their used vehicles falls below what they borrowed.

How Lenders Should React to Rising Delinquencies

Lenders should prepare now for the potential rise in consumer loan delinquencies by reviewing accounts and determining which are more likely to fall into delinquency. Rather than try to navigate the ever-increasing regulatory minefield that has been laid regarding the collection on past due accounts, banks, credit unions, and other lenders would be advised to consider bulk and forward flow sales.

Selling these loans now would mitigate risk, improve the balance sheets, and increase cash flow. Sellers can lock in today's favorable pricing, which is likely to be lower next year, Garnet Capital projects.

Selling these troublesome accounts requires a practiced hand to meet the regulatory requirements, and Garnet has the years of experience to become your trusted advisor in this process. When you have compiled a portfolio of loans you would like to clean off your books, contact one of our sales advisors to create a plan for disposing of the loans while prices remain at solid levels.

Lenders interested in purchasing and servicing these problematic loans also should reach out to Garnet Capital to learn about loan portfolios for sale.