Borrowers' Remorse

Consumers Show Signs of Frailty

What started with car loans has begun to spread.

If you were wondering when you should start worrying about weakening U.S. consumer credit, now is a good time.

Consumers have been defaulting on their car loans in greater numbers over the past year, and some analysts have chalked this up to overly loose lending standards in the auto industry. But now some Americans are increasingly struggling to repay their credit-card bills. This was on full display on Tuesday in Capital One’s first-quarter earnings results, which showed a much higher rate of loan losses among its credit-card unit than both its management and investors expected.

Rising Write-Offs

Capital One's card charge-off rates have risen to the highest level since 2011

Source: Bloomberg Intelligence

Not only did its provisions for losses in its U.S. card unit surge 33 percent from the preceding quarter, but Capital One also reported that its write-off rate in the unit rose to 5.1 percent, the highest in almost six years. In addition, the company changed its explanation for the rapid deterioration in credit quality, now attributing the weakness to consumer behavior rather than a surge in loan growth and aging loans, according to Bloomberg Intelligence's Ryan O'Connell.

Girding for Losses

Capital One set aside more money to cover losses on its credit-card loans

Source: Bloomberg Intelligence, company filings

"This isn't just a one-quarter blip. This is a change," O'Connell said in a Bloomberg Radio interview on Wednesday. "They sounded a lot more cautious on this call than they have," he added, noting that consumers have higher levels of indebtedness than they have in the recent past.

Capital One, of course, is singularly focused on subprime borrowers, putting it on the front lines of any potential loan losses. About one-third of its credit-card customers have below-prime credit scores and are generally more likely to miss payments. Besides, loan losses are rising from a relatively low level after years of historically good credit quality.

But Capital One is not alone in experiencing a faster-than-expected uptick in loan losses. Even Discover Financial Services, which caters to higher-rated clients, experienced a deterioration in the quality of its credit-card debt in the first quarter, with net charge-off rates rising to the highest level since at least the end of 2014.

A growing number of analysts are becoming concerned. It's true that mortgage debt has declined, making it seem as though households are deleveraging, but this is misleading, as UBS analysts Stephen Caprio and Matthew Mish pointed out in a report on Wednesday. They noted that U.S. consumer debt, not including mortgages, now equals an unprecedented 20 percent of the nation's annual economic output because of ballooning volumes of student and auto loans.

Deepening Debt

U.S. consumers have steadily added to their debt load over the past five years

Source: Federal Reserve

Data does not include mortgages

While the UBS analysts don't think that these obligations necessarily pose a systemic risk, they do say the growing risk of defaults isn't being priced into the market. Indeed, even though there were signs of growing trouble in credit-card debt weeks ago, it took until Capital One's latest earnings release Tuesday for the company's stocks and bonds to truly sink. On Friday, Synchrony Financial, another lender with a significant amount of clients with subprime scores, will issue its results. 

More than likely there will be additional unpleasant surprises in lenders' credit-card portfolios going forward, and investors should tread cautiously. The depth of consumer weakness hasn't been fully tested yet.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

    To contact the author of this story:
    Lisa Abramowicz in New York at

    To contact the editor responsible for this story:
    Daniel Niemi at

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