By Natalie DeCoste

Things are good for consumers right now in the lending market, but some worry that things may be a bit too good.

Currently, shares of lenders, including credit card, auto, student, and personal loan makers, are soaring this year. The strong showing is thanks to robust credit performance and a belief that rates will tick higher.

Growth for these companies is likely to continue as the economic recovery gains steam, fueling consumer spending and credit demand. Many lending firms are experiencing this credit demand already, with firms such as Ally Financial, Capital One Financial, LendingClub, and SLM all up more than 40% so far this year. This is roughly double the gain for S&P 500 financials overall.

This is not to say that the economy is back to where it used to be. JP Morgan’s credit and debit card sales dropped 23% year-over-year in Q2 2020, and Capital One saw year-over-year credit card loan balances and revenue decline. However, Capital One’s purchase volume rebounded compared to the first quarter of 2020. It did report strong credit and strong financial results in the domestic credit card market.

“Strikingly strong credit was the biggest driver of domestic card financial results in the quarter, just as it has been for the prior two quarters. The domestic card charge off rate for the quarter was 2.54%, a 214 basis point improvement year-over-year,” said Capital One’s CEO Richard Fairbank.

However, this growth does not mean that investors should not be cautious about the market’s long-term outlook. The current lending boom could eventually create conditions for higher defaults.

Fairbank warned of the potential dangers down the road for Americans in the company’s first-quarter earnings call. Consumers who appear creditworthy in the short term because of the federal stimulus checks, forbearance of other debts such as student loans or mortgage payments, and high collateral values for things like used vehicles pose a threat to lending companies. This short-term appearance may create significant harm down the road.

“I do want to flag that this period of unusually strong credit could lay the groundwork for credit worsening down the road as an industry point… Reliance on consumer credit characteristics that may be more temporary driven by things like stimulus and forbearance can be a real challenge for credit modeling. And the benign rearview mirror could encourage lenders to reach for growth and to loosen underwriting standards, which, as you know, can invite adverse selection. And then overlay on top of that, the excess liquidity and capital that’s out there, and that could push lenders to stretch for less resilient business,” said Fairbank.

Auto lending is one market where there is potential for harm to businesses and consumers down the line. In the automobile lending market, dealers often actively make lenders bid against each other. Less expensive debt both draws in more lenders and drives tighter pricing. This makes subprime lending more attractive because there are fewer lenders in that space.

While consumers should still enjoy the economic recovery period we are in now, lending companies should be careful to monitor the state of the market going forward.