How much longer will consumer credit hold up?

The remarkably strong loan repayment rates by U.S. consumers during the first seven months of the pandemic could be a harbinger of continuing durability, or they could be the prelude to a collapse.

Under one plausible scenario, Congress passes a big new stimulus package early next year, which shores up the finances of unemployed Americans until a COVID-19 vaccine is widely available. In the bleaker forecast, a cold-weather spike in coronavirus cases leads to another sharp decline in U.S. economic activity, and ongoing political gridlock prevents a repeat of the rescue that Washington provided in March 2020.

“If you see a wave of white-collar layoffs in December, January and February, then start watching payment rates very closely,” warned John Hecht, an analyst at Jefferies.

Hecht, who has been covering the consumer finance industry for about 20 years, has been shocked by how well the sector has performed this year, given the steep rise in unemployment. Historically, defaults on consumer loans have tracked closely with joblessness.

Delinquent loans at five large U.S. credit card issuers were down by roughly 40% in the third quarter, compared with the same period a year earlier, according to an analysis by Autonomous Research. Some of that reduction is due to lower loan volumes, since both lenders and borrowers have become more cautious, but much of it is the result of improved payment trends, which have persisted this fall even after the expiration of temporary forbearance offers.

Wall Street analysts point to a range of factors that have contributed to the surprisingly strong loan performance not only in the credit card business, but also in auto lending.

The list includes the expanded unemployment benefits that were part of the federal rescue legislation, the $1,200 checks that went to most Americans, the decline in consumer spending during lockdowns and the fact that deferrals of mortgage payments have allowed many consumers to keep paying their other bills.

On average, Americans used more than 70% of the proceeds from their stimulus checks either to pay down debt or to save, according to research by the Federal Reserve Bank of New York.

But it remains to be seen how long people who are out of work will be able to keep meeting their debt obligations. Research published recently by the JPMorgan Chase Institute showed that unemployed Americans roughly doubled their liquid savings between March and July, while they were receiving $600 per week in supplemental benefits, but then spent two-thirds of that new savings in August.

“Eventually, without further government support or significant labor market improvements, jobless workers may exhaust their accumulated savings buffer, leaving them with a choice to further cut spending or fall behind on debt or rent payments,” the authors wrote.

Hecht expressed little confidence in his own ability to predict how strong U.S. consumer credit performance will be a year from now. Normally he would establish a 12-to-18-month stock price target for the lenders that he covers, but he is now only trying to look out three to six months. “I feel like that might be as good a visibility as we have,” Hecht said.

Executives at various consumer lenders expressed similar sentiments during recent earnings calls.

“There’s a tremendous amount of uncertainty ahead, including whether further stimulus measures will be enacted,” said Brian Wenzel, the chief financial officer at Synchrony Financial, which specializes in store-branded credit cards, on Oct. 20.

Synchrony added $4.2 billion to its allowance for credit losses during the first six months of 2020, a 64% increase, as the Stamford, Conn.-based company anticipated a spike in losses. But during the third quarter, the percentage of Synchrony loans that were at least 30 days past due was 40% lower than it had been a year earlier. The firm’s loss allowance grew by just 4% between June and October.

Other consumer lenders are also in a holding pattern after making large reserve builds earlier this year. At Capital One Financial, the allowance for credit losses ballooned from $7.2 billion at the end of 2019 to $16.8 billion at the end of June. It declined by $700 million in the third quarter.

Capital One’s loss reserves could prove to be either too large or too small, depending on whether Congress approves another large relief package, according to Chief Financial R. Scott Blackley.

“More stimulus could be a significant positive factor,” Blackley said during an Oct. 22 call with analysts. But he added that in a scenario where the economy worsens beyond the company’s current assumptions, and new government stimulus spending is not forthcoming, “we might be looking at the potential for reserve additions.”

Across the credit card industry, issuers have established reserves that assume loss rates will nearly double over the next 18 months, according to an analysis by Sanjay Sakhrani, an analyst at Keefe, Bruyette & Woods. Sakhrani wrote in a research note published Monday that the issuers’ assumptions show conservatism, though he acknowledged questions about additional government stimulus spending, white-collar unemployment trends and the spread of the virus.

The credit outlook for 2021 may be rosier for auto lenders than it is for card issuers. That’s because the pandemic has led to changes in transportation patterns that are benefiting the car industry and figure to be at least somewhat enduring. The use of both public transit and apps like Uber and Lyft has declined sharply amid fears about the virus.

One result has been unusually strong demand for used cars, which has boosted vehicle prices and reduced the size of losses that lenders take when they repossess vehicles. In mid-October, the used-car value index from Manheim was 16.7% higher than it had been a year earlier.

Ally Financial, the Detroit-based auto lender, established a $3.25 billion allowance for credit losses at the end of March, up from $1.26 billion just three months earlier. But since then its allowance has only grown by about $130 million. Charged-off loans at Ally were down by more than 50% in the third quarter compared with the same period a year earlier.

For consumer lenders, the question now is how long the belated arrival of household financial woes can be forestalled.

“Until now, the performance has been shockingly good,” said Brian Foran, an analyst at Autonomous. “It almost feels too good to be true.”


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