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Canary in the Coal Mine? Subprime Credit Card Delinquencies Spike in Q2

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There are signs that the air may be coming out of the subprime credit card bubble.

According to numbers recently released by Federal Reserve, delinquency rates on credit card balances at commercial banks other than the largest 100 rose to 6.2% in the second quarter of this year. These are credit cards issued by the nearly 5,000 smaller banks in the US. According to Wolf Street, this actually exceeds the peak during the financial crisis and represents a better than 2% jump from a year ago.

Delinquency rates on credit cards issued by the largest 100 banks came in at 2.4%.

We see a similar disparity in the charge-off numbers. The number of credit card balances written off at the 5,000 smaller banks spiked three full percentage points year-over-year to 7.8% in the second quarter. That’s the highest level since the first quarter of 2010. According to Wolf Street, the charge-off rate among smaller banks peaked during the financial crisis in Q1 2010 at 8.4%.

Meanwhile, charge-offs at the 100 big banks in Q2 rose only slightly, coming in at 3.6%.

So, why the discrepancy between the biggest banks and the smaller ones and what does it tell us?

It tells that the riskiest borrowers are having trouble paying their bills.

During the financial crisis, commercial banks got clobbered by credit card write-offs as unemployed consumers couldn’t keep up with their payments. Big banks learned the lesson. In the years since the 2008 crash, bigger banks tightened lending standards and focused on the most creditworthy customers. They have competed for these borrowers with big cash-back offers, juicy rewards programs and low teaser interest rates.

Smaller banks can’t afford to compete for these customers, so they’ve focused on the higher-risk borrowers. These customers have weak credit, lower incomes, and little savings. This is the subprime credit card market. It’s not unlike the subprime mortgage market that blossomed in the runup to the 2008 crash. Banks can charge these customers higher interest rates, so it is a lucrative market. As Wolf Street noted, profits were initially huge, but now the air is starting to come out of the bubble, as evidenced by the skyrocketing delinquency and charge-off rates.

But the subprime segment of credit cards is concentrated at smaller banks because they targeted those customers to maximize their profits, and that subprime segment of customers is running into difficulty not because they lost their jobs, but because they borrowed too much at interest rates that are too high because the banks got too greedy with their most vulnerable customers.”

Small banks hold only a small fraction of credit card debt, so this deflating bubble won’t likely have any kind of broad impact on the economy. But it could be a canary in a coal mine.

Total household debt hit a record $13 trillion in 2017, eclipsing levels seen on the eve of the Great Recession. Americans have been burning up their credit cards. Revolving debt grew by $26 billion in the fourth quarter of 2017 alone, a 3.2% increase. Americans have run up a nearly $1 trillion credit card tab. Meanwhile, flows into serious delinquency have increased steadily since the third quarter of 2016.

This spike in subprime credit card delinquencies could be a sign that the American consumer is close to being tapped out. As Wolf Street put it, “Credit begins to unravel at the margin.” In other words, America’s borrowing binge could be nearing its limit.

This is not good news for an economy built on debt.

According to a recent report, the bottom 60% of American income-earners accounted for most of the rise in spending over the past two years even as their finances worsened. The data shows that the rise in median expenditures has outpaced before-tax income for the lower 40% of earners in the five years to mid-2017. In other words, poor and middle-class Americans are driving the US economy by spending more than they earn.

If Americans can’t borrow any more, what’s going to happen to the debt economy?

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