US consumers love to pay using credit cards. Credit card spending dominates all retail purchases (in dollar terms; the number of debit card transactions far exceeds that of credit cards), and the total number of credit accounts continues to grow as digital wallets remove the space constraint that physical wallets and purses previously imposed.
A vital driver of the business model’s economics is credit card debt, both at an industry level and for most card issuers. While “manage-able” revolve rates are generally positive for an issuer’s bottom-line, we believe that we are starting to see the early signs of financial stress among certain households. Given the current macroeconomic environment, issuers need to carefully monitor these segments and be prepared to act quickly if conditions further deteriorate.
Americans’ total credit card balances were $986 billion at the end of Q4 2022, according to the latest data from the Federal Reserve Bank of New York , up $61 billion from the previous quarter — the largest quarterly increase in the report’s history.
The chart shows credit card balances over the past decade, divided into three distinct phases:
Source: Federal Reserve Household Debt and Credit Report
Given the current trajectory of credit card outstandings, it seems very likely that the US will pass a major milestone in the next few months: US consumers will owe more than $1 trillion in credit card debt.
This raises a critical question: is this growth healthy or unhealthy?
It’s possible that the current uptick in credit card outstandings simply reflects pent-up demand coming out of the pandemic. As businesses have re-opened and travel restrictions have lifted, households may be using their credit cards to book a long-delayed trip or make a big-ticket purchase. A credit card allows households to smooth their cash flows over time, financing today’s consumption with tomorrow’s known earnings. Under this scenario, the spending and associated increase in debt is rational and well within households’ ability to repay.
There is, however, an alternative narrative. Under this scenario, households are using their credit cards to finance their everyday living costs, growing their total balances on a month-to-month basis. These households have been hit by two developments simultaneously: (1) the end of COVID-related government benefits and (2) broad based inflation, driving up the cost of groceries, gas and utility bills. This double whammy may be pushing household cash flows into the red, with credit cards being used to bridge the gap.
To discern which scenario is correct, we need to look at how households are using their credit cards.
Data at an industry level are inconclusive. The percentage of credit cards that are delinquent has increased sharply in the past 18 months but remains low relative to historic norms, as shown below.
Q1 2022 vs. Q1 2023, Based on Household Income; Sample Size = 150,000+ U.S. credit cardholders
Source:
Macro data, by its nature, reflects the aggregated behavior of hundreds of millions of credit card accounts. To better understand the underlying drivers of credit card debt, we need to look at the revolve characteristics of individual households.
FSG Insights, a top research and advisory firm, has a unique, proprietary data set that tracks US consumers’ credit card behavior. The firm captures a massive sample of credit card statements – at the cardholder level – permitting analysis by household demographics, issuer, reward program, APR and so forth.
We analyzed the credit card revolve rates of 150,000+ credit cardholders to examine how their repayment behavior has changed in the past year. In total, 46% of active U.S. credit cardholders are currently revolving a balance, up from 43% a year ago.
Critically, as shown in the chart, there are differences in the revolve trends based on cardholders’ household income. As has historically been true, lower income consumers are more likely to carry a credit card balance than others.
Q1 2022 vs. Q1 2023, Based on Household Income; Sample Size = 150,000+ U.S. credit cardholders
Source: FSG Insights
What’s most noteworthy now is the change in revolve rates by household income:
This divergence in households’ credit card behavior points to dynamics in today’s economy and helps answer the over-arching question. Specifically, for some cardholders, the growth in credit card outstanding is not a cause for concern, but for others, households’ increasing indebtedness is indicative of the broader strains facing certain segments. Not only are more lower income households revolving their credit card debt, those that do revolve also tend to carry higher balances (averaging $3,494, up from $3,280 in Q1 2022).
As issuers strive for greater interest income, they need to pay extra attention to cardholders’ ability to repay. Declining certain applicants may sacrifice some growth today but in return for much greater loss avoidance tomorrow.
Tony Hayes is the Founder and Managing Partner of Banking & Payments Group. He can be reached at tony.hayes@bankingandpaymentsgroup.com
Ed Bachelder is the Director of Research with Blueflame Consulting and Research, LLC, specializing in consumer & business market research and electronic bill payment. He can be reached at ed.bachelder@bflame.com