Is there a subprime credit-card crisis on the horizon?

Borrowers with a VantageScore between 300 and 600 across these four cohorts experienced an 8.9% delinquency rate — of 30 to 59 days — in July 2023, up from 7.49% a year earlier, VantageScore data reveals. Credit-card borrowers with a prime credit score (between 661 and 780) had a delinquency rate of 0.1% in July 2023, broadly in-line with the prior year.

Separate data support the VantageScore conclusions. Credit-card delinquency rates at smaller banks hit a record high of 7.51% in the second quarter of 2023, up from 6.01% at the same time last year, according to the Federal Reserve Bank. That contrasts with a lower delinquency rate of 2.63% in the second quarter at the top 100 banks, compared with 1.71% a year ago. 

The Fed focuses on delinquencies where borrowers have fallen past due 30 days or more. It defines large banks as those with $300 million or more in assets, while smaller banks are those outside of the largest 100 commercial banks. More than 80% of U.S. consumers had credit cards last year, with nearly half (48%) carrying a balance, according to Federal Reserve data.

“We’ve seen a huge increase in credit-card delinquencies,” said Balbinder Singh Gill, assistant professor of finance at the Stevens Institute of Technology’s School of Business in Hoboken, N.J. “In the U.S., we only seem to fix things when there is a crisis. I’m very worried about delinquencies, especially as these are impacting households with low wages.”

Although some commentators see that as a reflection of the credit worthiness of middle- and lower-income households, Lance Noggle, senior vice president, operations and senior regulatory counsel of the Independent Community Bankers of America, said these Fed figures don’t get granular enough to tell why credit-card delinquencies are shooting higher at small banks. 

With a 24% average APR on credit cards, falling behind could push those lower-income workers into bankruptcy, Gill said. “It’s a very dangerous situation currently, especially for low-wage workers.” What’s worse, consumers could end up paying late-payment fees of up to $35 per month if they default on their payments, and an APR of up to 30%, according to LendingTree.

One theory: some smaller banks loosened credit requirements after the recession in 2008 to lure customers and increase deposits. In 2018, Congress rolled back part of the Dodd-Frank Act in 2010 — which was designed to strengthen the banking system — further easing credit-requirement rules for smaller banks.

All of this comes at a bad time. Consumers, particularly low-income Americans, are under pressure. Student-loan repayments resume in October after the pandemic-era moratorium and interest rates are at a 22-year high. While the Fed has signaled it’s not likely to raise rates again imminently, inflation is still above the Fed’s 2% target rate.

“Wages are not increasing at the same rate as inflation,” Gill said. “People want to have the same standard of living. They want to buy the same food, but it’s impossible as their wages are still low, so they’re using their credit cards. That’s OK for the short term, but at the end of the day, you have to pay off the debt.”

‘Pockets of trouble’ are emerging 

More people are relying on plastic: Credit-card debt surpassed $1 trillion during the second quarter, a milestone pointing at consumers’ willingness — or need — to use credit cards. Economists say other life experiences like medical debt, divorce and job loss also can lead to a rise in credit-card debt, and increase the risk for delinquencies. 

The average credit-card balance in the second quarter of 2023 rose by 20% to $5,947 from a year ago, the highest level in 10 years, according to a quarterly report from TransUnion
TRU,
-1.17%
released earlier this month. The average credit limit per consumer reached a new all-time high for the second consecutive quarter, hitting $24,900, up 6.4% on the same period last year, the report added.

Subprime consumers, often people with lower incomes or a blemished credit history, are a bigger risk for lenders. Ted Rossman, senior industry analyst at Bankrate.com, a personal-finance website, sees “pockets of trouble” emerging. Many also are reaching a tipping point where their credit-card bills — and other debts — become overwhelming, he said.

“Half of credit-card holders pay in full every month, and avoid interest and life is great. They get rewards and buyer protections and all these benefits,” he said. “But the other half, more or less, is carrying debt at an average interest rate north of 20%, which is the highest we’ve ever seen. That can be a big deal at the household level.” 

Lenders, including credit-card issuers, are now tightening their lending standards, and this tends to be felt most by subprime consumers, Rossman added. As a result, they are more likely to turn to alternative avenues of credit, such as borrowing from friends and family and using fintech apps to request advances on their future paychecks to cover basic living expenses, he added. 

Are younger people falling behind? 

If all of this sounds familiar, it’s because we’ve been here before. The recent rise in credit-card debt delinquencies has a sense of “déjà vu,” Juan M. Sánchez, economist at the Federal Reserve Bank of St. Louis, and Olivia Wilkinson, research associate at the St. Louis Fed, wrote in an August report, referencing the 2008 global financial crisis. 

Their analysis of credit-card borrowers — across all credit scores — showed that younger borrowers were more likely to be behind on their credit-card bills. They cited unemployment rates and shorter credit histories among this cohort, although they said the overall financial situation of younger borrowers may not be as dire as in the wake of the 2008 crisis. 

They offered some explanations: when credit conditions are tight, banks may remove or reduce their promotional offers, such as 0% APR balance transfers, thereby restricting borrowers’ ability to consolidate their debts at a lower interest rate. Job loss, they added, is another reliable cause of credit-card delinquency. (U.S. hiring slowed again last month.)

The end of pandemic-era benefits has also put pressure on consumers. “However, thanks to forbearance programs, restrained spending during lockdowns and generous government benefits, households maintained record low delinquency rates during the COVID-19 recession and immediately after,” the researchers said.

“Although credit-card delinquency rates were low during the COVID-19 recession, they have been on the rise since the end of 2021,” Sánchez and Wilkinson wrote. “Current delinquency rates for younger people are near where they averaged in the 2007-2009 global financial crisis.”

The good news: The level of debt is not the same as during the Great Recession. “The delinquent debt as a fraction of total credit-card debt is smaller,” they added. “Data for the most recent quarters, however, suggest that households’ financial situation may be stabilizing, particularly for individuals younger than age 40.” 

Read: As credit-card debt tops $1 trillion, smaller banks see a worrisome trend