Delinquency Rates Still Low, But Rising
A curious juxtaposition over the past five years has been that despite all the political and economic turbulence around the world, banks and borrowers have been sailing along as if they were in relatively calm waters, at least as far as delinquency rates are concerned. Whether it’s home loans, consumer loans, business loans, or credit cards, the portions of each that were past due or in collections hit multi-decade lows from 2020-2023.
Why? A portion of it was just the math. Many of these loans carried low interest rates from 2020-2022 when the Federal Reserve had ratcheted rates down as part of an effort to prop up the economy; people can afford their monthly loan payments more easily if the interest rate is, say, 4% versus 8%. Foreclosure moratoriums by the government and forbearance initiatives by banks to allow borrowers to defer payments during the worst months of the pandemic undoubtedly helped get people through particularly tough times, as well.
There was also just a large amount of government stimulus and various forms of support floating through the system for several years. This included pandemic relief payments to individual Americans and families, but also massive amounts of relief for businesses including PPP loans and various other governmental support.
Lastly, although Americans have struggled with inflation, the unemployment rate has been very low, and when people are working, they are more likely to be able to keep with their loan payments. A strong labor market has helped borrowers keep up.
What Now?
While delinquency rates are still low relative to previous eras, they have recently started to rise. Consider the following:
Credit cards: delinquencies bottomed out at 1.53% in Q1 of 2021 and have risen to 3.08%, which is near a 12-year high.
Consumer loans: bottomed out at 1.52% in Q2 of 2022 and have risen to 2.75%, which is an actual 12-year high.
Commercial real estate loans: bottomed out at 0.63% in Q3 of 2022 and have risen to 1.57%, a 10-year high.
All business loans: bottomed out at 0.97% in Q1 of 2023 and have risen to 1.28%.
Home Loans: delinquencies bottomed out at 1.70% in Q3 of 2023 and have risen to 1.77% (this one is actually still very low and quite stable).
Are these delinquencies rates worth panicking over? Certainly not yet, but they do signal an economy that is starting to experience some softness. Delinquency rates are a potential leading indicator of harder economic times ahead.
Other key economic indicators are also showing softness. Consumer spending was down for the month of January, for example, and consumer sentiment continues to sour. Fewer new jobs were created in January than economists had expected (although the unemployment rate remains quite low at 4.0%), and inflation remains a touch too high.
As interest rates stay elevated and, importantly, as many commercial borrowers see their loans re-price as five-year fixed interest rate periods expire, expect delinquencies to continue to rise and the corresponding health of the underlying borrowers whether they be individuals or business start to falter. The ripple effects through the economy are likely to follow.
How to Handle Rising Delinquencies
If you are a borrower struggling to keep up with your payments, you likely have some options:
Loan deferrals: Banks may be willing to defer payments to the maturity of the loan (within reason) if you are facing short-term setbacks.
Loan re-amortization: Your bank may allow you to extend the repayment period. For example, a $250,000 business loan with a 10-year term might require $3,000/month payments. If re-amortized over 20 years, the payment could drop to around $2,300/month. While this means paying more interest over time, the lower monthly payment could provide needed relief.
Asset sales: Some borrowers may need to sell the asset securing the loan. This can be difficult—not least because it may mean giving up on a dream—but it can be necessary to avoid deeper financial distress.
Market Opportunities
It may seem crass to mention, but for real estate investors and those looking for business opportunities, rising delinquencies may loosen the market. Over the past few years, there have been few distressed sales of homes, commercial properties, or businesses. However, if the economy weakens further and borrowers struggle, those with capital on hand may find opportunities among sellers who need to exit.
Ben Sprague lives and works in Bangor, Maine as a Senior V.P./Commercial Lending Officer for Damariscotta-based First National Bank. He previously worked as an investment advisor and graduated from Harvard University in 2006. Ben can be reached at ben.sprague@thefirst.com or bsprague1@gmail.com.