The reward is growing for card lenders but also the risks | Mint

The reward is growing for card lenders but also the risks

People who need to borrow more to support their spending are also the kinds of borrowers that you generally worry a bit more about
People who need to borrow more to support their spending are also the kinds of borrowers that you generally worry a bit more about

Summary

People relying on their cards to borrow portends strong loan growth, but also possibly rising credit risk

Americans are signaling that they want to keep spending and borrow more. That is a good-news-bad-news situation for investors in card lenders.

The good news is that card loans grew by double-digit percentage points in the third quarter across the large U.S. credit-card issuers. But at the same time, the average delinquency rate for large card lenders jumped by more than a third over last year, according to figures compiled by Autonomous Research analyst Brian Foran. Capital One Financial said that the “normalization" of payment behavior was most pronounced among its most recent vintages of loans, which it said was a historically typical pattern during periods when credit risk starts rebounding from unusual levels.

The question is whether lenders should keep pushing and grow their loan books and net interest revenue into this emerging risk. There are good reasons to grow right now: Interest rates are rising, and the pressure to keep up with inflation may be increasing people’s need to carry balances. For example, Discover Financial Services said that its payment rate dipped in the third quarter, although the rate was still more than 4 percentage points above 2019 levels. More people borrowing, rather than just immediately paying down, generates more interest income.

There are also indications that despite the pickup in late payments, credit risk remains very manageable. The large U.S. card lenders’ delinquencies are on average still more than 20% below where they were in the third quarter of 2019, according to Autonomous. Many consumers also still have cash reserves: Synchrony Financial reported that only 40% of customers it has tracked that received stimulus payments have spent down that entire cushion in their accounts, up just slightly from 38% in July. It attributed that uptick to inflation and summer spending.

But people who need to borrow more to support their spending are also the kinds of borrowers that you generally worry a bit more about. Capital One Chief Executive Richard Fairbank told analysts on Thursday that the lender has long been seeking to add more heavy spenders who pay down their balances, and avoid people who revolve high balances. He described spenders as “pound for pound, a more resilient group" of customers.

Loan growth raises the stakes if there is a surge of credit risk past normal levels. In addition to slimming consumer cash buffers and more borrowers carrying balances, some lenders have also let their reserve ratios—or set-asides for loan losses as a percentage of loans—slip a bit, and others still remain below the levels they were at last year. Even though lenders widely built up more reserves in dollar terms in the third quarter, those reflected the fast growth of their portfolios as much as it did a view of rising economic risk.

Consumer lenders’ steady reserve ratios could be seen as a positive indicator, suggesting that while late payments and loan losses are expected to tick up to more typical levels, lenders don’t yet see a substantially higher risk they could surge past that point. Investors seem to have taken it that way: So far this month consumer-finance stocks in the S&P 500 have rallied more than the KBW Nasdaq Bank Index and the broader market.

But overall investors are also still pretty worried, with the group still trading at under 9 times forward earnings versus a 10-year average of around 12 times, according to FactSet data. It seems that little with cards is straightforwardly good or bad right now—which makes lender stocks a tough call.

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