Credit card delinquencies, the SLOOS, and Barkin wisdom
Welcome, market participants, to another 3 Things in Credit. I’m Van Hesser, Chief Strategist at KBRA. Each week we bring you 3 Things impacting credit markets that we think you should know about. This was the week that the S&P 500—otherwise known as the Mag 7 and the other 493—crossed 5,000. We dug out a Bloomberg survey of 18 Street strategists from December, asking for their year-end 2024 estimates for the index. Only seven of the 18 forecast above 5,000, and the median was 4,850. It feels like the price of risk has gotten ahead of itself.
This week, our 3 Things are:
Alright, let’s dig a bit deeper.
Credit card delinquencies.
There’s been a lot of attention paid lately to credit card activity—how credit card loans in the U.S. have hit an all-time high, and how delinquencies have bounced. A quick search of the Google machine finds these headlines: “Americans’ credit card […] delinquencies spiked in 2023.” Or this one: “Credit card delinquencies surged in 2023, indicating ‘financial stress,’ New York Fed says.”
The possible implications of what’s going on in the credit card world are significant, directly affecting investor sentiment to concentrated lenders such as Capital One or Discover or Synchrony, or towards consumer ABS, and more broadly to the ability for the almighty U.S. consumer to continue to drive economic growth. Is this a canary in the coal mine?
For insight, I naturally head towards Rich Fairbank, CEO for 30 years of Capital One, the fourth-largest card lender. Mr. Fairbank warned early on in the pandemic of two distortions happening in the consumer lending business: (1) that consumer credit scores would be unsustainably high due to stimulus benefits, and (2) that consumer loan losses would be delayed (i.e., pushed out) because of those same stimulus benefits. He also has warned of second-order effects during the pandemic of fintechs flooding the market, especially subprime, with credit offers, making every lender’s book worse. And he also warned about excesses taking place in the auto lending market. Check, check, check, check. Pretty good insight. So, what does he make of all of this?
He’s bullish. When asked about Cap One’s competitive response to the current market, he says, “We are leaning in, we’re definitely leaning in.” Despite Cap One seeing net loan losses in Q4 rise 213 bps year-over-year. Despite seeing 30+ delinquencies still on the rise sequentially. He confidently says bad debt “normalization has run its course and credit results have stabilized.” He expects the company’s loan loss rate to settle in at 15% above 2019 levels.
He marvels at that strength of the U.S. consumer—how “strikingly resilient” the labor market has been, the consumer’s relatively low debt burden, how real wages are growing again, and how home values have held up. From our perspective, that Q4 earnings call was a sure-footed exercise. Other market participants agreed. The stock jumped 5% after the call, which is not the usual “buy the rumor, sell the news” outcome.
Alright, on to our second Thing—The SLOOS is back.
Did the SLOOS, otherwise known as the Fed’s quarterly Senior Loan Officer Opinion Survey, have its 15 minutes of fame? Recall, in the wake of the bank failures last March, investors waited with bated breath for the next SLOOS to see just how much banks tightened their lending standards as managing deposits (and deposit outflows) became paramount. It was not lost on investors that banks tightening credit dramatically on top of the fastest rate-hiking cycle in 40 years could easily tip the economy into recession.
The good news is that banks no longer account for the majority of lending (as we discussed on this podcast last week), and markets have remained open and active. But, on the margin, and at the risk of stating the blindingly obvious, the economy performs better when credit flows.
So, what does the latest SLOOS, out this week, tell us? It tells us that banks in the aggregate are still tightening credit underwriting standards, but not as aggressively as had been the case in 2023.
Starting with commercial & industrial loans, the vast majority of banks (80+%) have not changed their underwriting standards in Q4, although those that did tightened. Not surprisingly, commercial real estate lending saw more pronounced tightening. On the consumer side of the ledger, banks are being a bit more cautious across products, but are well off of a shock reaction, the kind you would see if there was mounting evidence of an imminent recession.
The survey’s so-called “special questions” asked about expectations for 2024 for changes in lending standards, borrower demand, and loan performance. The most noteworthy expectation is among large banks and their credit card lending. In 2024, 40% of the 20 banks surveyed in the “large bank” category (that makes up most of the card market) expect to tighten the card lending box. None of them expect to loosen. As for auto lending, where there was increasing concern a couple of years ago, that market seems to have cooled, and 85% of banks expect to leave underwriting unchanged in 2024.
Interestingly, bankers expect demand for virtually all loan categories, commercial and consumer, to rise in 2024, consistent with the soft-landing narrative and improved visibility that goes with it.
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And as far as the quality of the bank’s current loan book, respondents believe that while C&I loans to non-leveraged large and midsized firms will hold up at high levels, there is more concern about deterioration, as you would expect, in leveraged and small-sized commercial borrowers, as well as in commercial real estate portfolios. Banks are also expecting consumer loan portfolios (credit cards, auto loans, and mortgages) to deteriorate somewhat in 2024.
All in all, the latest SLOOS is a step in the right direction toward banks becoming part of the solution economically rather than part of the problem.
Alright, on to our third Thing—The Fifth District wisdom of Tom Barkin.
While prepping for a morning meeting, I had Bloomberg TV on in the background, which had just started an interview with Tom Barkin, president of the Fed’s Fifth District in Richmond. A few tidbits got my attention, and I soon became much more engaged. A peek into his background helped to explain why. Thirty years at McKinsey, including stints as that firm’s CFO and chief risk officer. Does not hold a PhD in economics. A practitioner, as the academics say. I’m all ears.
Barkin acknowledged the data lately has been “remarkable” on economic growth, jobs, and disinflation. But he added that you have to take data with a grain of salt. He pointed to the latest jobs report where job growth was actually negative until seasonal adjustments took it up to the off-the-chart print of 353,000. Alright, a reason to curb my enthusiasm.
Next up, a discussion on the “neutral rate” and the debate raging now around this imaginary number. Mr. Barkin weighed in by pointing out that the standard deviation around the estimate is 200 bps, meaning the 2.5% figure in the latest Summary of Economic Projections could actually be anywhere from 0.5% to 4.5%. So, Mr. Barkin said policy decisions should be made not based on trying to hit some theoretical neutral, but rather based on what is being seen in the economy. Sounds logical, but it’s easy to see how scholars get tied up in their models.
Alternatively, Mr. Barkin seeks out trends in actual activity happening across his district. For example, he noted this week in a speech at the Economic Club of New York that the tone in his district has “shifted decisively away from talking about a recession,” except in “interest-sensitive sectors like banking and real estate.” And as far as the latter is concerned, he noted that much of CRE is in good shape; concern should be centered on downtown, B- and C-quality office properties, rather than tar the entire sector by the same brush. That’s a prudent perspective.
I also like the fact that he is aware of confirmation bias around data—you know, you highlight data that fits your story as opposed to having an open mind to whatever data comes across the tape. He is quite candid about recognizing that the economy has proven to be more resilient than he thought would be the case. In his words:
“The extraordinary levels of post-pandemic spending have been normalizing. The painful post-COVID-19 supply chain shortages have been largely resolved. The rebound in prime-age labor force participation and immigration have helped alleviate labor market pressures. And most measures of inflation expectations have stayed impressively stable, suggesting that businesses and consumers have found the Fed and our inflation target credible.”
He adds, however, two reasons for caution. One, there is no certainty about where the economy is headed. Monetary policy lags, credit tightening, narrowness of job gains, and possible reacceleration of inflation suggest going slow in terms of possible rate cuts. And two, we are not yet sure of what changes to the economy have occurred because of the pandemic. We do know that changes to labor participation, the housing market and globalization (we would add technology) are evident.
According to Mr. Barkin, we would be wise to take it slow from the policy standpoint.
So, there you have it, 3 Things in Credit:
As always, thanks for joining. Don’t forget to check in on KBRA.com for our ratings reports and our latest research. See you next week.
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