Peer Report - December 5th

Wall Street Journey recently released a report about US consumers, American Borrowers Are Getting Closer to Maxing Out. Last week, the Fed said it would maintain the current high-interest rate to achieve the 2% inflation target. Analyzing the consumption patterns of U.S. consumers can provide valuable insights into the potential trajectory of inflation.

The article initially points out that US consumers continue to demonstrate both willingness and the financial capacity to spend and saw a higher average card loan increase of 1.6% in October over September, compared to the usual 0.7% rise.

We can see that consumer spending remains robust, which supports the current US economy. The significant monetary easing during the pandemic and the booming job markets are key factors supporting current consumer spending. However, this spending is unsustainable, given that the money distributed during the pandemic has gradually been depleted, and the job market is slowing down.

The article highlights that delinquency and net charge-offs all increased higher than usual, indicating that American borrowers are getting closer to maxing out.  The charge-off occurs when the company decides to write off the debt as a loss due to the low probability of collecting the debt. Therefore, higher charge-offs indicate an increased likelihood of borrowers defaulting.  Even more worrisome is that “the rate at which card companies have collected on charged-off loans has recently been below historical norms.”

The massive vintage of credit can also be attributed to loosened standards among several underwriters, as shown in the report, so these consumers are likely to struggle to repay loans in a credit-tightening scenario. And the default rate may surge if those consumers’ financial situations are getting worse or the unemployment rates increase. Given that banks’ response is usually sluggish as they start to tighten their credit to borrowers after delinquencies have accelerated sharply, many hidden risks are laid down in US banks and even the US economy as it remains unclear whether there will be a significant wave of defaults. 

Though the report uses American Express whose delinquency is far lower than that of five big U.S. card lenders to give us some relief that challenges could be fairly concentrated within those with lower incomes, we shouldn’t forget that American Express plunged due to market concerns about its business as it increased provision for delinquency. (For more details, please refer to our previous report Asset in Spotlight - American Express Co) Thus, the potential significant default risks should pose a high level of concern.

On the flip side, the tightening credit environment, and the maxing out of credit lines can contribute to cooling down the economy and potentially lowering the inflation rate. This could be seen as good news for the Federal Reserve and the market, as controlling inflation implies there is no need to raise interest rates. In a word, slowing spending and tightening credit is a good thing for the current market but investors need to be more vigilant of the hidden risks. The report also warms the investors should be wary about jumping into consumer-finance firms though. We will also Stay tuned for further updates.


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