This week’s Chart Room shows aggregate consumer delinquency rates dropped sharply in the second quarter, reflecting an uptake in forbearances (provided by both the CARES Act and voluntarily offered by lenders), which protect borrowers’ credit files from the reporting of skipped or deferred payments.
As of 30 June, 3.6 per cent of outstanding consumer debt was in some stage of delinquency, a full percentage point decrease from the fourth quarter of 2019. The share of student loans that became delinquent dropped notably, as most federal student loans are covered by CARES Act administrative forbearances. With federally-backed mortgages also eligible for forbearances, the share of mortgages that transitioned into delinquency dropped from 3.5 per cent in the first quarter to 3.1 per cent in Q2. While not specifically protected by CARES Act, auto loans and cards also showed declines in their delinquency transition rates, reflecting the impact of government stimulus programs and some voluntarily offered forbearance options for troubled borrowers.
Meanwhile, unemployment reached 14.7 per cent in April, a record high since data began 72 years ago, before improving to 10.2 per cent in July. The U.S. economy saw the biggest quarterly plunge in activity ever- gross domestic product from April to June plunged 32.9 per cent on an annualized basis. The looming threat of recession underscores the importance to consumers of the $600 weekly pay checks, which expired 31 July, in augmenting income for the unemployed. Congress is still debating an extension to those payments.
For years, banks in the US have been tightening lending standards as delinquencies have been drifting down. But banks have also provisioned in advance for a potential spike in delinquencies - the question now is, have they adequately prepared? So far, the valuation multiples for the banking sector suggest the market thinks they have fallen short. But once delinquencies start rising, paradoxically, the banks could start outperforming due to the embedded negative expectations - indeed, this is what happened in 2008/09.
However, consumer spending will take some time to recover. Credit card balances declined sharply in the second quarter by $76 billion, the most on record, reflecting the drop in consumer spending due to the Covid-19 pandemic and related social distancing orders. Meanwhile, delinquencies of at least 90 days on credit cards, which were not paused by the CARES Act, rose to nearly 10 per cent of the balance, the highest level since the second quarter of 2013.
All of this suggests that the temporary government support measures are unlikely to be ‘temporary’. Perhaps universal basic income may not be so far off after all.