Early concerns about the credit problems linked to the pandemic did not materialize. But investors now also have reason to be cautious about the longer-term outlook, as the current loan boom could create conditions for higher term defaults. Last week, longtime Capital One chief executive Richard Fairbank offered “pattern recognition” on what he called the physics of credit markets. “This period of unusually strong credit could lay the groundwork for credit deterioration in the future, as an industry point,” Mr. Fairbank said.

One risk is that consumers only appear to be creditworthy temporarily, spurred on by stimulus measures, abstention from other debts such as student loans or mortgage payments, and high collateral values ​​for things like used vehicles. That, coupled with excess lender liquidity driven by an influx of deposits, could “push lenders to step up for less resilient businesses,” Fairbank said.

The auto loan seems to be a potential area of ​​excess. Mr. Fairbank noted that competition for auto loans can be particularly fierce because dealerships often actively bid lenders against each other. Santander Consumer executives told analysts last week that competition “has returned and is more intense in some ways than before Covid.”

The cheap debt available in the capital markets attracts more lenders and leads to tighter pricing. This makes subprime loans more attractive because there are fewer lenders in that space, but then the onus is even more on lenders not to overlook the financial health of borrowers based on the availability of government stimulus.

It could be a few years before a questionable underwriting today turns into loan losses. But many lenders are now trading at tangible price-to-book ratios higher than they led to the pandemic, so investors would be well advised to anticipate. Certainly, higher rates would increase returns. But competition among lenders will play a big role in how high rates can be, and higher rates could also be offset by even slightly higher credit losses.

Longer-term investors should look for companies that use last year’s dislocation to drive growth by aiming to attract good customers from their competitors, for example by increasing marketing spend. For example, American Express said last month that newly acquired new U.S. consumer card members had higher average FICO scores than those gained before the pandemic.

Macro-judgments can also become increasingly important. An economic recovery that is not just a rebound but a sustained and self-sustaining expansion can contain credit worries, helping lenders expand the borrower pool and continue to grow interest income even as margins are weakened. reduced.

The stocks of consumer lenders can still be good bets, but the easy money might already have been earned.

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