Credit card issuers are expanding access to borrowers with lower credit scores, signaling a shift in lending standards as the industry looks to rebuild portfolios following the pandemic. Rising credit card approvals among subprime consumers suggest that lenders are becoming more comfortable extending credit to higher-risk borrowers, even as economic uncertainty continues.
While broader credit access can benefit consumers seeking to establish or rebuild their credit histories, the trend raises questions about the potential for increased credit card defaults. With inflation accelerating, interest rates expected to rise, and household budgets facing mounting pressure, financial institutions must weigh the opportunities of subprime credit card lending against the possibility of deteriorating credit quality.
The WSJ reports on the trend of increased lending to subprime borrowers, and while it sounds like a great deal, you need to consider if the direction lays the groundwork for the next credit bubble.
An estimated 29.2 million general-purpose credit cards were issued to people with credit scores of 660 and below last year, according to projections from credit-reporting firm TransUnion, up from 20.4 million in 2020 and 26.3 million in 2019. That is generally the threshold where lenders view consumers as having fair, rather than good, credit.
Lenders issued roughly 11.6 million general-purpose credit cards to people with credit scores below 620 during the first nine months of 2021, according to the latest data by Equifax, up 43.5% from a year earlier and the highest for the period on record. (Equifax’s data goes back to 2010.) The aggregate spending limit on the cards rose 45% over the same period.
But, while approvals may be up, balances generated from the subprime group are not surging, says a TransUnion executive.
“Despite the increase in new accounts to subprime borrowers, we have observed that balances for subprime borrowers have remained relatively stable—a sign that consumers are not taking on too much risk.”
If the trend is to book lower credit cards, issuers must also prepare for a coming economic storm, as we mentioned in a recent Mercator report titled Credit Card Risk, Protracted Pandemic, and the Household Budget. In short, open credit lines amount to $3.9 trillion in the United States, but only 27% of those lines are used. That means Americans have open-to-buy amounts that total $3 trillion.
The economy remains unsettled. As the recent report illustrates, the prime rate is subject to change, and we will likely see an increase before mid-year 2022. Moreover, inflation is bubbling, and the WSJ reported that prices saw the “fastest annual growth in three decades.” You can only wonder how the household will navigate their credit card commitments when inflation and interest rates rise simultaneously.
If the WSJ is correct in saying that issuers are aiming towards lower credit score pockets, it is a risky proposition, and issuers would be better served to tighten their standards until the economy has clarity on inflation, interest rates, and even the long impact of the current COVID crisis. Although the WSJ does not elaborate on which issuers are loosening their standards, the proof will be in the pudding when the economy begins to deteriorate, and record low charge-offs reverse.
Overview by Brian Riley, Director, Credit Advisory Service at Mercator Advisory Group
