Goldman’s Apple Card business has a surprising subprime problem

The weakest American borrowers are starting to miss payments and default on their loans, and that is showing up at a surprising place: Goldman Sachs.

While competitors like Bank of America enjoy repayment rates at or near record levels, Goldman’s loss rate on credit card loans hit 2.93% in the second quarter. That’s the worst among big U.S. card issuers and “well above subprime lenders,” according to a Sept. 6 note from JPMorgan.

The profile of Goldman’s card customers actually resembles that of issuers known for their subprime offerings. More than a quarter of Goldman’s card loans have gone to customers with FICO scores below 660, according to filings. That could expose the bank to higher losses if the economy experiences a downturn, as is expected by many forecasters.

“People are losing their jobs and you had inflation at 40-year highs; that will impact the subprime cohort more because they are living paycheck to paycheck,” Michael Taiano, a senior director at Fitch Ratings, said in an interview. “With Goldman the question will be, were they growing too fast into a late-cycle period?”

The dynamic comes at a sensitive time for CEO David Solomon. Under pressure to improve the bank’s stock price, Goldman’s money-losing consumer operations have drawn headlines and the ire of some investors and insiders. The investment bank began its foray into consumer finance in 2016 to diversify from its traditional strengths of Wall Street trading and advisory activities.

But the journey has been a bumpy one, marked by leadership turnover and staff departures, missed product deadlines, confusion over branding, a regulatory probe and mounting losses.

Solomon will likely face questions from directors about the consumer business at a board meeting later this week, according to people with knowledge of the matter. There is internal dissent about who Solomon has picked to lead key businesses, and insiders hope he puts stronger managers in place, the people said. Some feel as though Solomon, who moonlights as a DJ on the international festival circuit, has been too extroverted, putting his own personal brand ahead of the bank’s, the people said.

Goldman’s credit card business, anchored by the Apple Card since 2019, has arguably been the company’s biggest success yet in terms of gaining retail lending scale. It’s the largest contributor to the division’s 14 million customers and $16 billion in loan balances, a figure that Goldman said would nearly double to $30 billion by 2024.

But rising losses threaten to mar that picture. Lenders deem bad loans “charge-offs” after a customer misses payments for six months; Goldman’s 2.93% net charge-off rate is double the 1.47% rate at JPMorgan‘s card business and higher than Bank of America’s 1.60%, despite being a fraction of those issuers’ size.

Goldman’s losses are also higher than that of Capital One, the largest subprime player among big banks, which had a 2.26% charge-off rate.

“If there’s one thing Goldman is supposed to be good at, its risk management,” said Jason Mikula, a former Goldman employee who now consults for the industry.  ”So how do they have charge-off rates comparable to a subprime portfolio?”

The biggest reason is because Goldman’s customers have been with the bank for less than two years on average, according to people with knowledge of the business.

Charge-off rates tend to be highest during the first few years a user has a card; as Goldman’s pool of customers ages and struggling users drop out, those losses should calm down, the people said. The bank leans on third-party data providers to compare metrics with similar cards of the same vintage and is comfortable with its performance, the people said.

Other banks also tend to be more aggressive in seeking to recover debt, which improves competitors’ net charge-off figures, the people said.

But another factor is that Goldman’s biggest credit product, the Apple Card, is aimed at a broad swath of the country, including those with lower credit scores. Early in its rollout, some users were stunned to learn they had been approved for the card despite checkered credit histories.

“Goldman has to play in a broader credit spectrum than other banks, that’s part of the issue,” said a person who once worked at the New York-based bank, who asked for anonymity to speak candidly about his former employer. “They have no direct-to-consumer offering yet, and when you have the Apple Card and the GM card, you are looking at Americana.”

After the 2008 financial crisis caused by undisciplined lending, most banks shifted to serving the well-off, and competitors including JPMorgan and Bank of America tend to focus on higher-end borrowers. The exception among big banks was Capital One, which focuses more on subprime offerings after buying HSBC’s U.S. card business in 2011.

Capital One says 30% of its loans were to customers with FICO scores below 660, a band that contains near-prime and subprime users. That’s within spitting distance of Goldman’s proportion of sub-660 customers, which was 28% as of June.

Meanwhile, JPMorgan said 12% of its loans were to users with below-660 scores, and Bank of America said that 3.7% of loans were tied to FICO scores under 620.

After a period in which borrowers fortified by Covid pandemic stimulus checks repaid their debts like never before, it is the industry’s “newer entrants” that are “showing much faster weakening” in credit metrics, JPMorgan analyst Vivek Juneja wrote last week.

“Goldman’s credit card net change-off ratio has risen sharply in the past 3 quarters,” he wrote. That is happening “despite unemployment remaining very low at 3.7% in August, similar to 2019 levels.”

That has forced the bank to set aside more reserves for potential future credit losses. The consumer business is on track to lose $1.2 billion this year according to internal projections, Bloomberg reported in June. The “vast majority” of the consumer investments this year are tied to building loan reserves, thanks in part to new regulations that force banks to front-load their loss reserves, Solomon told analysts in July.

That figure could get worse if a recession forces them to set aside more money for soured loans, executives have acknowledged.

The difficulties seem to confirm some of the skepticism Goldman faced when it beat out established card players to win the Apple Card account in 2019. Rivals said the bank could struggle to reach profitability on the no-fee card.

“Credit cards are a hard business to break into,” said Taiano, the Fitch Ratings director. “Goldman already faces higher losses because their book of business is young. But when you layer on worse unemployment, you are exacerbating that trend.”