Widespread Deferrals Raise Questions on Creditworthiness

Banks have pulled back sharply on lending to U.S. consumers during the coronavirus crisis. One reason: They can’t tell who is creditworthy anymore.

Millions of Americans are out of work and behind on their debts. But, in many cases, the missed payments aren’t reflected in their credit scores, nor are they recorded on borrowers’ credit reports.

The confusion stems from a provision in the government’s coronavirus stimulus package. The law says lenders that allow borrowers to defer their debt payments can’t report these payments as late.  From March 1 through the end of May, Americans deferred debt payments on more than 100 million accounts.  According to TransUnion, this signals widespread financial distress.

The credit blind spot has further clouded the outlook for lenders. For years, strong consumer spending and borrowing helped propel them to record profits. Now the economy is in shambles, and they are trying to figure out what is going to happen to all of the debt Americans racked up in better times.

Lenders that are having a tough time spotting risky loan applicants are approving fewer borrowers for credit cards, auto loans and other consumer debt. They are also hunting for new data sets that could indicate who is in financial trouble and how much they need to set aside to cover soured loans. The Federal Reserve last week said the biggest U.S. banks could be saddled with as much as $700 billion in loan losses in a prolonged downturn.

“Without accurate information, their only option is to pull back on credit,” said Michael Abbott of Accenture PLC. “Banks don’t know who is going to pay and who isn’t. It’s like flying blind into a credit storm.”

Banks started tightening their underwriting standards in March, when the first wave of coronavirus layoffs began.

In an April Federal Reserve survey, 33% of banks said they had increased their minimum credit-score requirements for credit cards over the previous three months.  This is up from 14% in January. Bank respondents tightened lending standards for all consumer-loan categories.

Source:  Wall Street Journal