Consumer lenders start to feel pinch as fears of virus spread

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It’s hard to believe — given the panic that gripped financial markets on Monday — but the S&P 500 closed at an all-time high less than three weeks ago.

That buoyancy was in large part the result of the enduring strength of the U.S. consumer economy. Unemployment was at its lowest level in February since the late 1960s. Consumer confidence remained high, while the latest consumer lending data showed an encouragingly small percentage of borrowers who were behind on their payments.

Today, mid-February feels like ancient history, and an urgent question for lenders is: Just how badly will coronavirus fears affect consumer spending?

Initially, observers who worried about the economic impact of the coronavirus outbreak focused mostly on disruptions in supply chains from China. But in recent days, as countless events are getting postponed and air travel dwindles, fears have been growing about the virus’ impact on U.S. consumer demand.

Read more: Complete coverage of the coronavirus impact

One fragmentary piece of evidence from the U.S. travel industry: four days after disclosing a significant decline in customer demand and an increase in trip cancellations, Southwest Airlines informed customers Monday that it will be expanding the use of hospital-grade disinfectant throughout its planes.

Christopher Gillock, executive chairman at Colonnade Advisors, said that he expects U.S. credit card spending to decline in the short term. “It could be precipitous, once the numbers come through,” he said.

Card issuers that focus heavily on the travel segment should take a bigger short-term hit than those whose customers use their cards more for routine purchases like gas and groceries.

Over the longer run, Gillock raised the possibility of a fairly lengthy economic crunch, which would likely spark a rise in unemployment and make it difficult for many borrowers to pay their debts. Household debt topped $14 trillion in the fourth quarter of 2019 and has hit record highs in each of the last 19 quarters, according to data from Federal Reserve Bank of New York.

“Consumers are leveraged,” Gillock noted. “Auto debt is at an all-time high. Credit card debt is up there. Student loans, forget about it.”

Early Monday, eight Democrats on the Senate Banking Committee urged banking regulators to issue guidance encouraging financial institutions to modify terms on loans to consumers and businesses affected by the virus. Federal and state regulators released a statement late in the day, urging lenders to "work constructively with borrowers and other customers in affected communities. Prudent efforts that are consistent with safe and sound lending practices should not be subject to examiner criticism."

So far, U.S. consumer lenders have said little publicly about the possibility of a recession and the impact it would have on their profitability. That may be in part because the situation is evolving so rapidly.

Just last month, a survey of U.S. consumers by the New York Fed found a slight increase in median household spending growth expectations. The survey also found a decline in the perceived probability of missing a minimum debt payment over the next 12 months.

Similarly, an index of consumers’ financial confidence developed by the economist Dan Geller found that anxiety levels, as measured by consumer behavior, fell in February.

But over the last two weeks, the KBW Nasdaq Bank Index, an index of large and regional bank stocks, has lost nearly one-third of its value and is now at a four-year low. One likely factor is the Fed’s emergency decision on March 3 to cut interest rates by half a percentage point, since lower rates typically mean tighter margins for banks.

But investors are also beginning to anticipate more rate cuts — and even the possibility of a severe recession.

On Monday, shares in the country’s largest retail banks, including JPMorgan Chase, Wells Fargo, Bank of America, Citigroup, PNC Financial Services Group and U.S. Bancorp, all fell between 12% and 16%.

Analysts at Keefe, Bruyette & Woods wrote in a research note Monday that the share prices of some consumer lenders have already fallen by a larger margin than their earnings would be expected to decline as a result of a modest recession in the second half of the year.

Companies that fit this profile include American Express and the student lender Sallie Mae, according to KBW.

Investors in certain other U.S. consumer lenders, including Capital One Financial and Discover Financial Services, had not fully priced in the impact that a modest recession would have on the firms' expected profitability, according to the KBW analysis, which did not factor in Monday’s massive sell-off in equities.

"The situation remains fluid and will also depend on whether the impacts are short or long lived," the KBW analysts wrote.

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