Credit card delinquency rates at smaller banks are raising questions about differences in lending strategies and risk exposure across the U.S. banking industry. While overall credit conditions may appear relatively healthy, smaller issuers are experiencing significantly higher delinquency and charge-off rates, suggesting that some consumers are encountering greater difficulty managing their credit card debt.
Part of the disparity may be explained by differences in lending models. Large banks can continue expanding credit card balances, affecting delinquency and charge-off ratios measured as a percentage of total receivables. Smaller institutions may serve different borrower segments and operate with greater risk tolerance, leaving their portfolios more exposed when borrowers begin to struggle.
Something I learned about credit, back in the 1970s and early 1980s is that you can lend your way out of a collection mess. With metrics tied to “a percentage of receivables”, if you lend more, you can supress the bad loans. Sooner or later, when lending tightens, you have to pay the piper, but in the interim, aggressive lending cures many ills.
Here is an interesting view from Wolf Street that resonates to the lending strategy of the past.
- In the third quarter, the “delinquency rate” on credit-card loan balances at commercial banks other than the largest 100 banks – so the delinquency rate at the 4,705 smaller banks in the US – spiked to 6.2%. This exceeds the peak during the Financial Crisis for these banks (5.9%).
- The credit-card “charge-off rate” at these banks, at 7.4% in the third quarter, has now been above 7% for five quarters in a row. During the peak of the Financial Crisis, the charge-off rate for these banks was above 7% four quarters, and not in a row, with a peak of 8.9%
- These numbers that the Federal Reserve Board of Governors reported Monday afternoon are like a cold shower in consumer land where debt levels are considered to be in good shape. But wait… it gets complicated.
The net result: large banks have been lending, which keeps the nominator and denominator in synch.
- In other words, the overall banking system is not at risk, the megabanks are not at risk, and no bailouts are needed. But the most vulnerable consumers – we’ll get to why they may end up at smaller banks – are falling apart.
- The rate is figured as a percent of total credit card balances. In other words, among the smaller banks in Q3, 6.2% of the outstanding credit card balances were delinquent.
- The fact that this process is now taking on real momentum — as demonstrated by delinquency rates spiking at smaller banks — shows that the group of consumers that are falling apart is expanding. And these are still the good times, of low unemployment in a growing economy.
The takeaway here is the many issuers outside the ranks of top-tier lenders operate on a different model that permits risk tolerance. These issuers also have large merchant side businesses that add revenue to the total business model.
The big question here is can the “other” issuers, almost 5,000 in number, co-exist? Moreover, what happens if the economy dives?
Rising credit card delinquency rates at smaller banks do not necessarily indicate widespread instability throughout the banking system. However, they can provide an important signal about the financial health of more vulnerable consumers and the risks associated with different credit card lending strategies.
The greater concern is what happens if economic conditions deteriorate. Smaller issuers experiencing elevated delinquencies and charge-offs during a period of low unemployment and economic growth could face substantially more pressure during a downturn. How effectively these institutions balance lending growth, credit risk, and revenue from other parts of their businesses will help determine how well they can withstand a weaker economy.
Overview by Brian Riley, Director, Credit Advisory Service at Mercator Advisory Group