Goldman’s (GS) Apple Card business has a surprising subprime problem

Weaker US borrowers are starting to miss payments and default on their loans, and it’s showing up in a surprising place: Goldman Sachs.

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

The profile of Goldman’s card customers actually resembles that of issuers known for their subprime offers. More than a quarter of Goldman’s card loans went to clients with FICO scores below 660, according to deposits. This could expose the bank to greater losses if the economy slows, as many forecasters predict.

“People are losing their jobs and you’ve had inflation at its highest level in 40 years; it will have an impact on the subprime cohort more because they live paycheck to paycheck,” Michael Taiano, senior director of Fitch Ratings, said in an interview. “With Goldman, the question will be, did they grow too quickly in 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 loss-making consumer operations attracted securities and the anger of some investors and insiders. The investment bank began its foray into consumer finance in 2016 to diversify its traditional strengths from Wall Street trading and advisory businesses.

But it’s been a bumpy ride, marked by executive turnover and staff departures, missed production deadlines, confusion over branding, regulatory investigation and mounting losses.

Goldman Sachs CEO David Solomon performs at Schimanski night club in Brooklyn, New York.

Trevor Hunnicut | Reuters

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

A viral success

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

But mounting losses threaten to spoil that picture. Lenders consider bad debts to be “write-offs” after a customer hasn’t made payments for six months; Goldman’s net charge rate of 2.93% is double JPMorgan’s card industry rate of 1.47% and higher than Bank of America’s 1.60%, though it only represents a fraction of the size of these transmitters.

Goldman’s losses are also greater than those of Capital One, the largest subprime player among major banks, which had a write-off rate of 2.26%.

“If there’s one thing Goldman is supposed to be good at, it’s its risk management,” said Jason Mikula, a former Goldman employee who is now an industry consultant. “So how do they have charge rates comparable to a subprime wallet?”

Apple Card

The main reason is that Goldman clients have been with the bank for less than two years on average, according to people familiar with the company.

Imputation rates tend to be highest in the first few years a user has a card; as Goldman’s client base ages and struggling users drop out, those losses should subside, the people said. The bank relies 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 debt collection, which improves competitors’ net write-off numbers, the sources said.

But another factor is that Goldman’s biggest credit product, the Apple Card, caters to a wide swath of the country, including those with lower credit scores. At the start of its deployment, some users were stunned to learn that they had been approved for the card despite having a verified credit history.

“Goldman has to play in a broader credit spectrum than other banks, that’s part of the problem,” said a former executive at the New York-based bank. “They don’t have a direct-to-consumer offer yet, and when you have the Apple Card and the GM Card, you’re looking at Americana.”

Spit distance

After the 2008 financial crisis caused by unruly lending, most banks turned to the wealthy, and competitors such as JPMorgan and Bank of America tend to focus on high-end borrowers. The exception among the big banks was Capital One, which is more focused on subprime offerings after purchase HSBC’s cards business in the United States in 2011.

Capital One says 30% of its loans went to customers with FICO scores below 660, a band that contains near-prime and subprime users. This is a step away from the proportion of less than 660 Goldman customers, which was 28% in June.

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

After a period in which borrowers bolstered by pandemic stimulus checks paid off their debts like never before, it’s the “new entrants” to the industry who are “showing a much faster weakening” of credit metrics, a wrote JPMorgan analyst Vivek Juneja last week.

“Goldman’s net credit card exchange rate has risen sharply over the past 3 quarters,” he wrote. This is happening “despite unemployment remaining very low at 3.7% in August, similar to 2019 levels.”

Assembly losses

This forced the bank to build up more reserves for potential future credit losses. The consumer sector is on track to lose $1.2 billion this year according to internal projections, Bloomberg reported in June. The “vast majority” of the bank’s consumer investment this year is tied to building up loan reserves, thanks in part to new regulations that require banks to preload their reserves against losses, Solomon told analysts in July.

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

The difficulties appear to confirm some of the skepticism Goldman faced when it beat established card players to win the Apple Card account in 2019. Rivals said the bank may struggle to achieve profitability on the card without costs.

“Credit cards are a tough business to break into,” said Taiano, director of Fitch Ratings. “Goldman already faces higher losses because its business portfolio is young. But when you make unemployment worse, you exacerbate that trend.”

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