Garnet Capital Advisors Blog

A hefty increase in consumer credit card usage and higher costs due to inflation in the last two quarters of 2022 have increased Americans' credit card debts to their highest levels in 20 years, according to the Federal Reserve.

The rising inflation, whose pace has surged near its highest in more than 40 years, has forced American households to borrow substantially more to cover the increased prices of commodities, driving the total revolving consumer debt close to $1.2 Trillion.

Another large contributor to the worrying debt load comes from mortgage balances, which, according to the New York Federal Reserve researchers, surged $1 trillion to over $11.7 trillion in just one year. Concurrently, credit card balances collectively jumped by over $38 billion since the second quarter of 2022, the highest jump in a single quarter over 20 years.

In the same period, the charge-off rates also rose sharply, although the figure is still lower than the pre-pandemic levels. According to the researchers, the increase in credit card debt is due to a combination of various factors, top among them consumers exhausting the $931 billion stimulus payments made by the federal government directly to the consumers.

With the stimulus funds spent, consumers are now relying on their credit cards to fund their lifestyles and to pay for their lifestyles. This reliance on revolving consumer debt is increasing the financial burden of the lenders, causing debt distress problems, credit defaults, and charge-offs.

How Credit Card Outstandings and Delinquencies Are Affecting Lenders

There are clear signs that the credit card delinquency bubble is already forming. The upswing in consumer borrowing and an increase in credit card balances for the third straight quarter of 2022 is worrying lenders. This is mainly because the last quarter of the year is not expected to be any better, as consumers will traditionally borrow more to spend during the holiday season.

As credit balances and inflation rise, the writing is on the wall: consumers will borrow more and delinquency levels will rise. Consumers will continue to struggle to pay off the higher balances, and unless the pace of income gains changes, the situation will get worse.

The downstream impact is that lenders may be forced to enact more stringent lending policies for consumers needing credit to stay afloat. According to Fed researchers, the income gains may keep up with the rapidly increasing prices and inflation, ultimately driving inflation.

Reports from major credit card companies reveal that younger consumers and borrowers with lower incomes accumulated the most credit card balances. CreditCards.com reported that as many as 60% of Americans who carry credit card debt month-to-month have been in debt for the last year, a 10-point increase from a year ago. This is the group that is at the highest risk of delinquency.

In addressing the concerns of the rising risks of credit card delinquencies, banks and the financial industry are maintaining a positive viewpoint. In different banks' recent earnings reports, the word 'normalization' came up more than a handful of times as the lenders confirmed that while defaults and delinquencies continued to rise, they are yet to reach worrying levels.

Credit card companies are preparing for a rougher holiday period and the first quarter of 2023 by bolstering their reserves to protect themselves from expected credit losses. According to a Senior Loan Officer Survey by the Fed, an impressive 95.7% of credit card issuers have maintained approval standards in the face of higher risks in the last quarter of 2022. Seemingly, their approach is a mix of cautious optimism and emergency preparedness.

Investors Anticipate Distressed Debt Opportunities

There is a silver lining to the rising credit card balances and delinquencies, even as the economy continues to struggle. Abundant times are nigh for distressed debt investors after years of marginal pickings.

Traditionally, card issuers sell their charged-off debts to a sophisticated, efficient, and compliant debt market. This financial market segment has suffered for extended periods due to low Fed interest rates enacted at the height of the pandemic, consumers' easy access to borrowing, and stimulus payments. According to Garnet market reviews, prices in this market hit a 20-year high by mid-year 2022 and prices have softened as the increase in supply affects prices.

The shifting market conditions, inflation, and overall poor economic performance are already making it harder and more expensive for individuals to clear their credit card balances. In the recent past, consumers could repay their overdue obligations and clean up their balance sheets, but this is becoming a great challenge driving them into credit distress.

The turning of the consumer credit cycle is here, and as default rates and delinquencies increase, credit card debt could stay high for years. The typical consumer is expected to continue relying on credit in 2023 and, as such, drive the charge-off rates even higher. This will drive supply higher, but the pricing for defaulted debt may continue to drop sometime in the year.

The long-term impact of credit card outstandings and delinquencies on distressed debt pricing will largely depend on how the economy performs in 2023. According to the economists at Wells Fargo, there is a good chance that the next recession may be mild compared to the last two.

The more optimistic outlook presents a scenario in which fewer face unemployment, there will be moderate salary raises, and a significant number of consumers will adjust spending by the third quarter of 2023. However, the financial system is projected to stay stable, and credit card issues will mostly stay the course until the situation improves.

The Bottom Line

The economy is projected to improve, consumers will be able to settle their credit card balances, and banks and credit card issues will bounce back. However, the financial situation will get worse before it gets back up. Players in the financial sector have few options aside from selling their loans to free up capital and to serve other borrowers. Buying and selling loans can be very complex, especially because the process has to adhere to strict regulatory requirements. Contact Garnet today to either add to or sell loans on your books.