When considering how bad COVID-19 credit delinquencies will be, we start with this fundamental principle: bad economy begets higher unemployment begets increased delinquencies. Its veracity has been proven time and again. Now we have an extreme case of a bad economy begetting higher unemployment. The economic shutdowns caused by COVID-19 has caused unemployment claims unlike anything we’ve ever seen.
Consequently, the unemployment rate has gone up as well. It registered 11.1% in June. This was actually lower than April and May’s rate, as some states started to re-open. It is still a very high rate unemployment rate however.
The resurgence of COVID-19 cases in a number of states is forcing a pause or even reversal in re-opening currently. A reasonable hypothesis would be that unemployment will remain fairly static for July.
For collections groups, understanding both unemployment and its effect on delinquencies is of significant value. Many financial institutions have offered payment deferrals and forebearance. But those bills will be coming due. How well prepared are collections groups to flatten the curve and to manage for bad debt, not just daily cash collected?
Well, let’s understand how bad delinquencies can get.
Connecting delinquencies with unemployment
An initial question is what is the relation between unemployment and delinquencies? To investigate that, I downloaded monthly unemployment rates (link) and first-time credit card delinquency rates (link) going back to 2004.
The question: do delinquencies spike the same month unemployment goes up? Is there a delay between unemployment and the effect on delinquencies? A delay between unemployment and delinquencies would make sense, as the cash flow disruption fully manifests in a household over time.
Using the r-squared metric that measures correlations between two sets of data, we see that a two-month lag between unemployment and first-time delinquencies has highest association.
| Comparison | r-squared |
| same month | 38.8% |
| 1 month lag | 39.4% |
| 2 month lag | 40.6% |
| 3 month lag | 37.8% |
Using the two-month lag, what might first-time delinquencies look like the next several months? Two possibilities are presented here.
Forecast #1: COVID-19 credit delinquencies
We have actual unemployment rates for May and June, which using the two-month lag rule, allows a forecast of July and August first-time delinquencies. But what to think about upcoming months? As the pause on reopening in several states shows, it’s hard right now to confidently forecast future unemployment. For our purposes, we’re going to use projected unemployment from The Financial Forecast Center.
Applying the two-month lagged correlation between unemployment and delinquencies to the projected unemployment, we arrive at this forecast for first time credit card defaults:
| Month | Projected first time defaults |
| Jun 20 | 9.05% |
| Jul 20 | 8.30% |
| Aug 20 | 7.11% |
| Sep 20 | 6.09% |
| Oct 20 | 6.36% |
| Nov 20 | 6.52% |
| Dec 20 | 6.58% |
| Jan 21 | 6.58% |
| Feb 21 | 6.25% |
| Mar 21 | 6.14% |
| Apr 21 | 6.14% |
To put those delinquency rates in perspective, here’s the average monthly first time delinquency rates for the previous three years:
- 2017: 3.48%
- 2018: 3.51%
- 2019: 3.31%
The upcoming delinquencies represent a significant increase over what credit card companies have experienced. And it’s possible those projected delinquencies are too low.
Forecast #2: COVID-19 credit delinquencies
In 2008-10, we went through the Great Recession, with unemployment ballooning up to 9.0% and higher. That’s a rate comparable to what we’re seeing here in 2020. We have the credit card delinquency data for that period. What it shows is eye-opening:
| Month | First Time Defaults | Unemployment two months earlier |
| Jun 09 | 8.33% | 9.0% |
| Jul 09 | 8.18% | 9.4% |
| Aug 09 | 8.18% | 9.5% |
| Sep 09 | 8.12% | 9.5% |
| Oct 09 | 8.27% | 9.6% |
| Nov 09 | 8.34% | 9.8% |
| Dec 09 | 8.17% | 10.0% |
| Jan 10 | 8.22% | 9.9% |
| Feb 10 | 8.46% | 9.9% |
| Mar 10 | 8.93% | 9.8% |
| Apr 10 | 9.14% | 9.8% |
| May 10 | 8.88% | 9.9% |
If that precedent were to hold here given the higher unemployment, the amount of delinquencies that financial institutions face will be historic in nature. The end of deferral and forbearance grace periods will be akin to a dam wall breaking.
Indeed, there are worrying signs out there. Mortgage delinquencies hit 3.4% as of April, a level higher than what what was seen during the Great Recession.
Our BackOnTrackTM delinquency mitigation platform provides a scalable way to reduce recidivism without human intervention, and to predict which customers are more likely to roll forward. Click here to find out more about how BackOnTrack’s tools will help with the upcoming collections surge.
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