Forbearances, an agreement to forestall collection activity against a delinquent account, give the consumer a short-term solution to suspend payments in a time of need. Mercator Advisory Group covered the topic in a recent viewpoint titled Credit Card Account Forbearance: Not Forgiveness and Not Forever.
In the context of credit cards, forbearance freezes delinquency aging. It disrupts the aging flow and protects the account from charging off as required by the Office of the Comptroller of the Currency (OCC), which applies to all national banks and their operating subsidiaries. In 2000, the OCC reaffirmed the delinquency trigger with this explicit rule:
- The policy establishes standards for classification and account management of retail credit in banks and thrifts. It generally requires that closed-end loans be charged off when 120 days past due and that open-end credit be charged off when 180 days past due.
Credit cards are open-ended credit because there is no explicit term. Once the card is open, charging can occur until the card expiration date; in the most common case, the card will be re-issued.
From a consumer’s perspective, forbearance provides breathing room; forbearance suppresses charge-off from the financial institution’s perspective, which you see in the current numbers. The fact of the matter is that December 2020 charge-offs for U.S. credit cards were only 2.62%. A year earlier, before COVID, the rate was 3.75%. Simply put, today’s numbers are about a third better than the prior year, even though most people know the global economy is unsteady.
CFPB’s Latest Announcement on Mortgages
On April 5, the Consumer Financial Protection Bureau (CFPB) proposed that forebearances be extended on mortgages through 2021 year-end. CFPB cites this data:
- Millions of families are at risk of losing their homes: As of February 2021, there were nearly 3 million homeowners behind on their mortgages, with an estimated 2.1 million mortgages in forbearance and at least 90 days delinquent. If current trends continue there may be 1.7 million such loans in September 2021.
- Preventing foreclosures helps homeowners and communities: Foreclosures are expensive for homeowners, with an average cost to borrowers of at least $12,500. Neighboring homes also lose value, with sales prices dropping by 1 to 1.6 percent after nearby foreclosure sales. Families who endure foreclosure are likely to suffer other harms as well, including broader financial distress and housing instability.
- The housing crisis is deepening racial inequality: Black and Hispanic homeowners were more than two times as likely to be behind on housing payments as of December 2020, according to a March CFPB report
What About Credit Cards?
The CFPB is silent about credit card forbearances at this point, which is appropriate. In our view, unsecured, open-ended credit should not extend the forbearance process for cards because forstalling aging overstates a receivable’s health. There is no credit manager worth their salt that suggests that a parent does not pay a doctor’s visit over a credit card or let a mortgage go into foreclosure to pay a delinquent credit card bill.
Still, at the same time, it is essential to have a good sense of how risky the credit card portfolio. As mentioned in a recent Mercator Report, Credit Card Charge-off Collections Takes Brains, not Brawn; unsecured consumer collections require finesse to resolve problems. The context of secured household lending is very different. It is hard to replace a home that goes into foreclosure; for credit cards, there are many options once the household returns to normal.
For now, there is no direction, but perhaps a realistic look at the health of credit card portfolios will require that the numbers represent the safety and soundness of the receivable. And that will mean higher charge-offs in 2021 and 2022. For credit cards, that is far better for consumers, financial institutions, and investors to face than an out-of-control delinquency wave that has been understated for two years.
Overview Provided by Brian Riley, Director, Credit Advisory Service at Mercator Advisory Group