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Rising Credit Card Charge-Offs Pose $1 Trillion Question

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(Bloomberg Gadfly) — After years of packing on debt, more American consumers are struggling to pay their credit card bills.

Credit card charge-offs have been rising steadily, posting their biggest surge since 2015 in February. Lenders from Capital One Financial Corp. to Discover Financial Services have ratcheted up loan-loss provisions and reported increasing delinquencies. This has raised concern among analysts and investors alike, especially when paired with the fact that card loans outstanding just surpassed $1 trillion for the first time since the financial crisis.

— (Related on ThinkAdvisor: Kicking the Credit Card Addiction)

The consequences could be significant for some lenders, especially private-label card companies including Synchrony Financial and Alliance Data Systems Corp., which both report earnings next week. These firms are likely to be canaries for broader weakness among consumers because they cater to subprime borrowers unlike, say, American Express Co. or JPMorgan Chase & Co.

Also, these lenders partner with brick-and-mortar retailers such as J.C. Penney and L Brands. Synchrony and Alliance depend on these retailers to sign up new credit-card accounts, and, as Susquehanna International Group analyst James Friedman noted, they tend to miss payments more frequently if retailers close stores near them or file for bankruptcy. These retailers are facing their own troubles, and a slowdown in sales may hamper the credit-card companies’ ability to bring in new business.

Indeed, Bloomberg Intelligence analyst David Ritter expects Synchrony and Alliance loan originations to slow this year. Meanwhile, charge-offs are increasing across the board, but the rates are higher at lenders that have a greater proportion of subprime borrowers. For example, about 30% of Synchrony’s card clients have credit scores below prime, while competitors such as JPMorgan, American Express and Discover focus mainly on prime borrowers, Bloomberg Intelligence data show. Capital One also has a significant proportion of clients with subprime credit scores, so it’s worth watching this firm’s earnings on April 25 as well. Bond investors have already started stepping away from Capital One and Synchrony as they grow more worried about their sizeable proportion of subprime borrowers, according to Bloomberg Intelligence’s Ryan O’Connell and Himanshu Bakshi.

To be clear, this doesn’t signal imminent collapse by any means, for either the $1 trillion of credit card debt or these lenders.

Loss and delinquency rates are still relatively low. Synchrony in particular has been exceedingly successful at expanding its business online, which arguably puts it in a better spot to attract younger customers going forward relative to bigger competitors.

But this consumer weakness is a new dynamic after years of households paying down debt and saving their money. Suddenly, investors are paying much more attention to how quickly lenders are increasing pools of money to compensate for unpaid bills. It doesn’t seem as if the creditworthiness of consumers is deteriorating at an alarming pace, but it’s concerning that so many people are failing to pay their bills when the economy is supposedly accelerating.

It’s especially worrisome that credit card lenders are still aggressively trying to rake in new business. They want consumers to borrow more — even if that means that more customers end up getting in over their heads — as long as it means they get bigger interest rates and more revenue that offset increasing losses. This will only make the lenders and, more important, the consumers more vulnerable when the economy starts to contract.

Credit card debt isn’t a serious problem spot yet. But it’s important to watch, with next week’s earnings offering clues into how quickly loan quality is deteriorating.

— Read Investing in Times of Trump, and Inflation on ThinkAdvisor.