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Consumer Credit and the Future Borrowing Base

In this post we focus on core borrowers, specifically members of the millennial generation and younger, exploring critical trends that will likely shape their borrowing behavior, and your strategy, for the foreseeable future.

The Consumer Debt Picture

Consumer credit may be granted in the form of a loan, a line of credit, or a credit card, and typically involves an agreement between the borrower and the lender that outlines the terms of repayment, including the interest rate, fees, and other charges. Due to the involvement of significant collateral requirements, mortgage loans are typically not included in consumer debt balances. That leaves us with credit cards, auto loans, student loans, personal loans, and the like.

Consumer debt, or “non-housing” debt as referenced in the chart below, occupies an increasing share of total debt. The trend is easily observable in the chart, especially between 2019 Q1 and 2022 Q2 -a time period that includes the COVID-19 pandemic and government stimulus response.

The chart below breaks down the consumer debt picture to a more granular level, showcasing student loans, credit card, auto loan, and other miscellaneous non-housing debt that contributes to the overall debt balance. (The above chart and the one below are courtesy of the Federal Reserve Bank of New York.)

The consumer debt situation has captivated the headlines of financial news sources over recent months, specifically when it comes to the summative amount of credit card debt (the orange area above). According to the Federal Reserve Bank of New York (FRBNY), 2022 Q4 credit card debt is estimated to be around $990 billion dollars – an increase of about $150 billion since 2022 Q1.

The almost 18% increase in credit card balances in the span of about a year is due in large part to inflation. Inflation has largely eaten into purchasing power through widespread cost increases. Life is simply much more expensive.

As typical daily expenses have ratcheted upwards, so has the percentage of Americans who are living paycheck to paycheck. The latest estimate is 64%, which is indicative of amplifying financial hardship on a broader scale. Given precarious financial situations, households and individuals have relied heavily upon credit cards to park expenses as they wait for paychecks to roll in.

It is worth noting that the trend of increasing national credit card balances has been mostly consistent throughout the time period shown on the FRBNY chart above, except for the years between 2009-2012, in which balances actually declined. The key distinction between the pre- and post-pandemic trends is an increase in the steepness of the line-item debt balance lines, which are more apparent under closer observation.

Trouble for Millennials and Young Borrowers

With respect to age, the Federal Reserve Bank of New York distinctly notes the current financial strain on younger borrowers, particularly with regard to credit cards, but also with auto loans (green area on the second FRBNY chart). To quote their finding directly, “since 2019, American millennials in their 30s have seen their total debt load rise 27% to $3.8 trillion as of the fourth quarter of last year.” The spike in debt is attributed mostly to more expensive lifestyles (to include inflation influences, the increasing costs of vehicles and homes (and related loan balances), and student loans.

A critical question is whether these debts are getting paid on time.

According to the FRBNY, the delinquency rate for credit cards held by millennial and younger borrowers has surpassed pre-pandemic norms. Comparatively, borrowers in their 50s and older have fared slightly better; their delinquency rates are roughly equivalent to pre-pandemic norms.

Similarly, this trend extends to auto loans. Many millennial and young borrowers are beginning to miss payments at more concerning rates, whereas older borrowers are missing payments on a level that is consistent with more historical norms.

Considering “historical norms” and consistency, it’s important to note that the average age of a credit union member today is about 53 years old. Debt profiles are markedly different by age – life stages, income levels, and financial goals vary by generation. Historical context is also a key driver when thinking about financial products such as mortgages and even student loans. Thus, the debt picture almost inherently becomes more complex the younger the borrower is.

Student Loans a Generationally Unique Problem

To further expand on the debt profiles based on age, consider the presence of student loans. Student loans make up the highest proportion of debt on the FRBNY “Non-Housing Debt Balance” chart above (specifically the red area).

Also, according to the Education Data Initiative, borrowers between the ages of 30-39 and under the age of 30 make up 54% of all student loan debt holders. This is shown in the below bar graph.

The Borrower Profile

The simple conclusion to the rising delinquency rates on credit card and auto loan payments, coupled with the concentration of student loans among millennial borrowers and borrowers in their 20s, is that financial hardship is widely present and shows no immediate signs of improvement.

This doesn’t discount the plight of borrowers in their 40s, 50s, and beyond, but the most emergent problems will come from millennial and younger borrowers due to the more complicated construction of debt profiles, and the long-term impact of negative marks on credit reports should woes with repayments continue.

On the Horizon

As the year progresses, it is worth keeping a close eye on the Federal Reserve’s continued fight against inflation via their influence on interest rates. If interest rates continue to rise, this will inherently impact credit card APRs. As the Fed sets the federal funds rate, banks and financial institutions use the rate to determine their own prime rate and by extension, the range of APRs that are offered to borrowers. More expensive credit may pose an issue to borrowers who are already hamstrung by high card balances that they are unable to pay off.

Moreover, higher interest rates will also impact the terms attached to both auto loans and student loans, making credit a lot more expensive to obtain. For borrowers hit with negative marks on their credit reports, higher rates will continue to complicate the matter even more, amplifying one of the principal problems of high debt in the first place. As stated earlier, “life” has simply become so expensive that many younger people need credit (and in some cases a lot of it) to finance it.

Your Response

What’s a credit union to do given rising delinquency and charge offs, escalating debt levels, and the persistent cost of living increases younger borrowers are grappling with? The easiest solution is to ignore the young borrower segment all together, letting that average age keep creeping older. But that isn’t a real solution, especially considering the credit union mandate.

What you should be considering is…

Education: Educational efforts will be well-received, but your programming must be context-specific. For example, educating on proper management of credit is not helpful if you already have a problem. If you know your younger borrower base (or even potential borrower base) is likely to be overburdened, start your educational conversation with that reality in mind.

Relevant Policies: Lots of younger borrowers have student loans. If your policies make it nearly impossible for a young borrower to work with you if they already have an abundance of student loans, then you aren’t an option for them today (and you likely won’t be a consideration for them in the future). Make sure you assess the impact of your underwriting policies on credit access for today’s younger borrowers, and make adjustments to allow for room to work with them.

Risk Mitigation: The word mitigation literally means “reducing the severity.” It does not mean eliminate. If you truly want to serve younger members, embrace a relevant policy approach as described above, and mitigate risk – meaning set aside more funds in your allowance account, charge your collectors with being extra diligent, and the like.

One last thing to consider… remember your older members’ stories. So many of our older credit union members recall that their credit union was the only place that would help them back in the day. That willingness to be a resource created unyielding loyalty, and the same opportunity to build a loyal foundation for next-generation members is before you right now. One of your key objectives should be to capitalize on it.

One response to “Consumer Credit and the Future Borrowing Base”

  1. […] situation draws us back to a point we made in our article on consumer credit, when we discussed how credit unions should respond given rising delinquencies and charge offs, […]

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