Retail Credit Cards: What’s Driving Delinquencies?
This is the second of a two-part blog series written by guest author, Cristian deRitis, senior director of Consumer Credit Analytics at Moody’s Analytics. Cristian develops credit models for a variety of asset classes and provides regular analysis and commentary on consumer credit, housing, mortgage markets, securitization, and financial regulatory.
In the first post of this series, we established that delinquency rates on private label retail credit cards has been rising over the past five years – faster than any other consumer credit product. This is occurring at a time when retailers are under immense pressure. Brick-and-mortar stores are struggling to differentiate themselves to compete with online retailers, and many are defaulting because they just can’t keep up. But what else is contributing to this upward trend in retail card delinquencies?
Four Factors Contribute to Retail Card Delinquency
Given the upward trend in retail card delinquency rates over the past few years, Moody’s Analytics ran an analysis where we decomposed the change in payment performance into one of four factors:
- Credit quality – If more credit cards are being issued to borrowers with poor credit, it would be natural to expect that delinquency rates would rise. As long as credit card companies are being fairly compensated for the additional risk, then there is little concern for lenders. However, consumers may be getting stretched.
- Age of the portfolio – Credit card payment performance follows a natural lifecycle. Delinquency and default rates tend to be higher in the quarters immediately following card issuance. Some borrowers commit fraud and never intend to make payments. Other borrowers may incur too much debt over a short period of time and struggle to make payments. Borrowers who make timely payments without defaulting over the first couple of years tend to be stronger, leading to lower default rates. Therefore, a younger retail card portfolio will tend to be riskier than an older portfolio, with all else being equal.
- The economy – Credit card borrowers who live in a weak or declining economy will face greater challenges making their payments than borrowers living in areas where the labor market is strong.
- Other factors – These may include the impact of external shocks, such as the closing of retail stores, shifts in consumer behavior or preferences and subtle, implicit shifts in underwriting that are not captured in observed credit quality.
We found that shifts in credit quality accounted for the bulk of the increase in delinquency rates. Credit card issuers simply gave more credit to borrowers with lower credit scores over the past five years than they did in the previous five years. Retail credit card portfolios also became younger as a result of this expansion of credit. Although there were pockets of local economic weakness over the past 10 years, most areas actually experienced substantial improvement. So the observed deterioration in performance was unrelated to the economy.
The most interesting result from our study was the observation that a significant portion of the increase in losses was attributable to other factors. Retail store closures can account for some of the behavior, but the trends are too wide spread to explain all of the deterioration. Rather, we hypothesize that subtle shifts in underwriting may have played a role.
Even if issuers did not change their explicit underwriting standards, the underlying credit quality of their applicants shifted. A strong economy may boost overall credit quality, but can mask or make it difficult to identify the true applicant risk. That is, it’s easier to make monthly payments when the job market is strong, making it harder to distinguish between borrowers. Unless lenders actively tighten their lending standards as the economy expands, they may run the risk of allowing riskier borrowers into their portfolios. This appears to have been the case with at least some of the retail card portfolios.
What’s Next for Retail?
Although restructuring of the retail industry may not be over, it appears to be stabilizing with many department and chain stores reporting strong earnings in recent months. Trends in retail credit card performance have shown some signs of stabilization, as well as credit card issuers taking steps to rein in some of their underwriting to combat rising losses. With the unemployment rate continuing to fall and demand for credit strong, banks and other lenders may be tempted to loosen up “just one more time” before the next recession. While short-term gains are tempting, history shows that the worst loans tend to be made in the best of times. As a result, lenders – as well as borrowers – will want to proceed with caution.
For more information on the correlation between retail store closures and private label card performance, read part 1 in this blog series, “Retail Credit Cards: The Correlation between Retailer Health and Payment Performance.”
Register now for our Q3 US Economic and Credit Trends Outlook webinar on Tuesday, Aug. 21 from 1-2 p.m. ET. Equifax chief economist, Amy Crews Cutts, will cover the latest on credit card performance trends and other insights that can help drive strategic growth at your organization.
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